20 July 2018
GBP: Stormy outlook as dark clouds gather over Westminster

We think the stormy political clouds over Westminster will remain in place until at least October – and are thus confined to pencilling in a 1.27 to 1.28 trough for the pound against the dollar in the third quarter (EUR/GBP at 0.92). This accounts for a significant degree of political uncertainty – in spite of the Bank of England raising rates in August

Summary: Short-term GBP downside risks as politics outweighs economics

All the drivers for the pound have turned on their head – with a strong dollar (weak global economy), domestic political uncertainty and a muted UK economic cycle all weighing on the pound. We think the stormy political clouds over Westminster will remain in place until at least October – and are thus confined to pencilling in a 1.27-1.28 trough for GBP/USD at some point in 3Q18 (EUR/GBP at 0.92). This compares to our previous third-quarter forecast of 1.34-1.35 for GBP/USD and 0.88 for EUR/GBP.

This near-term downgrade accounts for a significant degree of political uncertainty – in spite of the Bank of England raising rates in August. While we could be positively surprised by the Brexit progress, we feel the balance of risks suggests that further uncertainty is more likely between now and October – so long as the UK government's Brexit strategy remains one that is seemingly trying to fit a square peg into a round hole.

ECB preview: The meaning of summer

Some ECB veterans might be longing for the good old days when the bank's summer meeting was held in the form of a teleconference. With little news, ECB President Mario Draghi will simply reiterate the main message of the June meeting

What will be on the ECB's mind?

With the announced de facto end of QE at the June meeting, the ECB clearly stuck out its neck on the outlook for growth and inflation in the eurozone. The discussion on the sustainability of the recovery and any acceleration of inflation will continue.

Soft patch or downswing? In our view, the jury is still out on whether the eurozone only went through a soft patch in the first months of the year or is actually already in the middle of a protracted cooling. While hard macro data released since the ECB’s June meeting has been encouraging and points to stable growth in the second quarter, soft indicators have only shown tentative signs of a bottoming out. On top of that, increasing trade tensions and growing geopolitical uncertainty could further undermine sentiment in the eurozone. Which direction will prevail? The one of sound and re-strengthening fundamentals or the one of a gradual denting of domestic confidence on the back of increasing trade tensions?

Inflation pick-up, still more wish than reality? As regards inflation, it's still hard to share the ECB’s confidence in a convergence of underlying inflation towards the ECB’s target. On the back of higher energy prices, headline inflation has returned to the 2%-level but the fact that core inflation dropped to 0.9% year-on-year in June shows that the ECB still has a long way to go, to say the least. However, do not expect the ECB to deviate from its June assessment. Rather, expect it to focus on the bright side. 

Metal price outlook: When the going gets tough…

Escalating trade tensions and fears about the impact on global growth, and with it metals demand, have wiped 15% off the industrial metal index from its June peak. But keep calm, we expect the rhetoric to die down after the US mid-terms and prices to recover

A disappointing year-to-date for the bulls

At the end of 2017, it all looked so bright for commodities. Macro themes of higher inflation and synchronised global growth provided a solid backdrop for commodities as a broad asset class. Being long the basket was a popular strategy and as funds built allocations through December 17, a brief return of correlation was ushered in, as prices went up across the pack.

But disappointment soon set in and with it, cross-commodity correlation has lulled once again.

Earlier in the year, Chinese demand wobbled amid a longer than expected New Year slowdown. This was a temporary blip but enough to reinstate copper back below $7k, with evident signs of macro funds already losing faith and liquidating positions.

That move has since been eclipsed by a 16% drop following the G7 summit, as a tit-for-tat trade war undermines the initial premise of synchronised global growth. Unlike the first quarter however, the recent sell-off has been different. It has spread beyond just a liquidation of what was already fairly flushed-out fund longs, to now also inviting a hoard of fresh shorts that are actively chasing a collapse in base metals.

This is evident through the increasing open interest on the LME through the turmoil of the first half of July. Shorting zinc ranks at the top but it's certainly a common trend across the base metals. We think there is a high likelihood for a decent size rebound as those shorts take profits and cover positions, but we acknowledge it will largely be the sentiment around trade wars that will take the steer for the next quarter, at least.

Our forecasts, therefore, see a slight short-covering rebound from spot in the third quarter, but we still see prices remaining largely depressed through the quarter, as our economists expect President Trump to stick to his hard-line trade rhetoric in the run-up to the November mid-term elections.

Thereafter, it gets more plausible that a deal or compromise is sought, so most price improvement should come about in the fourth quarter. Our trade economist has identified fairly minimal direct impacts to GDP from the trade tariffs (and with it minor impacts to metal demand) unless an all-out US vs. the world trade scenario unfolds. Moreover, it’s the indirect hits to business and market sentiment that pose the biggest risks and that should let up with the rhetoric. The Shanghai Stock Index shows the damage done in the meantime and is down 10% since the start of June.

If you agree with our thesis that much of this trade war gloom will roll over, then metals certainly stand a good chance of recovering. The rebound will be aided by a reversal in the dollar as those safe haven flows into the greenback die down and critical US issues return to the fore (twin deficits, tight mid-term elections etc). ING’s FX team predict the dollar at 1.23 against the euro by year-end, going down to $1.35 by the end of 2019. But we don’t think metals will recover their losses so quickly. The physical trends for many metals are pretty tepid so might not provide much in the way of direction.

Crude oil: Free fallin’

An escalation in the trade war, supply returning from Libya and Nigeria and the potential for the US to tap its emergency Strategic Petroleum Reserve, have all weighed heavily on the market. While we remain comfortable with our current forecast for weaker prices, we do believe the market remains vulnerable

Time to say goodbye to the backwardation?

One of the most interesting changes in the oil market has been the ICE Brent forward curve, the front end has flattened considerably, which has seen the backwardation in the prompt spread flip to contango. Trade war concerns do seem to have pulled out a lot of macro money from the oil market, along with the broader risk-off approach across the commodities complex. The flatter curve does now appear to be more aligned with a somewhat weaker physical market. A flatter curve also means that the market becomes less appealing to those speculators who have enjoyed the roll yield, and so the potential for further long liquidation at the front end, keeping the curve under pressure. 

The same however cannot be said for WTI. While the prompt WTI spread has come in considerably since the start of July, from over $2.50/bbl to just under $1/bbl currently, the curve is still in deep backwardation, with the spot US physical market looking tighter. Inventories in Cushing have fallen to 25.7MMbbls, down from 57.6MMbbls at the same stage last year, and the lowest inventory levels at the WTI delivery hub since 2014. The 360Mbbls/d Syncrude outage in Alberta, Canada will certainly not help, with the facility only expected to be fully operational by September. As of yet, flows from Canada do not seem to have been affected, in fact, Canada exported a record 3.73MMbbls/d the week following the outage. However moving forward, this loss in supply should start to feed through to lower flows into the US. Syncrude recently stated that they will cut supply to buyers by 35% over August.   

China: GDP forecasts cut on trade war

The ongoing trade war will affect future GDP directly via the manufacturing and logistics services sectors. Though the government will provide support via fiscal and monetary policies, it is inevitable that industrial production will slow, which could hurt wage growth and consumption

As expected GDP rose 6.7% YoY

GDP grew 6.7% YoY in 2Q, slightly lower than 6.8% in 1Q. Consumption was still the growth engine, contributing 78.5% of economic growth in 1H18, followed by investment (31.4%) then net exports (-9.9%).

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In Case You Missed It: Nothing thrilling

In a quiet week for economic data, politics once again set the tone for global markets. President Trump's remark that he's "not thrilled" about Fed rate hikes, escalating fears of a trade war and ongoing uncertainty over Brexit further muddied the outlook for investors and led us to revise some of our near-term forecasts 

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