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Euro as a Casualty as US-China Trade War Turns into Something Bigger

Much volatility was seen in the markets last week with a lot of themes developed. Canadian Dollar ended as the strongest one as strong data boosted chance of August BoC hike. Swiss Franc followed as the second strongest on risk aversion in Europe. Dollar was original set to perform better as trade tension escalated again. But it only ended as the third strongest after Chinese intervention in Yuan, as well as mixed non-farm payroll report. Meanwhile, Sterling was the worst performer after dovish BoE hike. Euro followed as second weakest as it’s a casualty of US-China trade war.

Canadian Dollar boosted by strong economy and NAFTA optimism

Canadian Dollar ended as the strongest one last week with support from optimism in the economy, as well as progress in NAFTA renegotiation. GDP grew an impressive 0.5% mom in May, with broad-based strength. 19 out of 20 industries reported growth, except utilities. Further than that trade data released on Friday also showed resilience, with 2.1% jump in export in volume terms. And more importantly, the June data revealed that after steel and aluminum tariffs by US came in to effect, steel exports dropped -37% mom while aluminum export dropped -7%. Growth elsewhere were more than enough to offset such contraction.

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There was some jitter for Canadian Dollar as the country was kicked out of the bilateral NAFTA talks between the US and Mexico. Traders initially took that as a negative but could have later changed their mind. There appeared to be some concrete progress between the US and Mexico. Mexican Economy Minister Ildefonso Guajardo declared on Friday that major stumbling blocks were cleared. And, he added that “technically, we are ready to move into finishing the issues, Mexico-U.S. issues, the most next week. There are very good probabilities that we’ll be landing solutions.” Also Guajardo said there could be a deal before end of August and Canada could jump in any time to make it trilateral.

The markets are now seeing around 75% chance of another rate hike by Bank of Canada in October.

From intermarket correlation point of view, weakness in oil price could be a factor that holds the Loonie back. Nonetheless, while WTI crude oil struggles to regain 70 handle on recovery, it’s just hovering around a flat 55 day EMA. And based on diminishing downside momentum as seen in daily MACD, even in case of another fall, downside will likely be contained by 38.2% retracement of 42.05 to 75.27 at 62.58 to set the range.

Sterling weakened broadly after dovish BoE hike

Sterling ended as the weakest one last week primarily due to the dovish rate hike by BoE. The decision to raise the Bank Rate by 25bps to 0.75% matched general market expectations. The unanimous 9-0 vote at first looked hawkish with doves giving in. But at a second glance, it’s indeed the result of compromise that the next hike is quite distant away.

The most important part of the announcement was found in the quarterly Inflation Report. There, BoE used a conditioning path that implied Bank rate will hit 0.9% in Q4 2019 1.1% in Q4 2020 and stay there till Q3 2021. In May’s conditioning path, the Bank rate will reach 1.0% already in Q3 2019, and then 1.2% in Q3 2020 and stays there till Q2 2021. That is, the current path argues that the next hike could happen in Q1 2020, instead of Q3 2019. And there could be no more rate hike in the forecast horizon.

Also, with such conditioning path, GDP (exclude backcast) is projected to growth faster by 1.5% in the four-quarter to Q3 2018, and 1.8% in the four-quarter to Q3, 2019. But GDP growth in the four-quarter to Q3 2020 is unchanged at 1.7%. Inflation will return to target later at 2.0% in Q3 2021, instead of Q3 2020. But, at 2.2% in Q3 2019 and 2.1% in Q3 2020, it’s reasonably close to target.

The dovish message was further affirmed by BoE Governor Mark Carney during the press conference. Carney said that tightening would be gradually as “structural factors that have pushed down the trend equilibrium real rate are likely to persist.” It will be limited because “domestic short-term factors (particularly headwinds from uncertainty and fiscal drag) will fade slowly.” Also also R* is expected to rise only gradually, and “policy needs to walk – not run”.

Sharp fall in DAX weighed down Euro and lifted Swiss Franc

Euro ended the week as the second worst performer while Swiss Franc was the second biggest gainer. Such could be explained by risk aversion in the European markets. DAX gapped sharply lower on Thursday after disappointing results of Siemens and BMW. Escalation of trade tension between US and China also weighed on sentiments.

The DIHK Chambers of Industry and Commerce also warned that US-China trade conflict is already hurting German companies doing businesses in the two countries. Its trade chief Volker Treier warned that “the impact is huge: nearly half of the imports from German companies are directly or indirectly affected by the new tariffs, for example because they source raw materials or components from the other country.”

So, Germany would inevitably be affected by global trade tension even though EU could strike a deal with the US to avert direct auto tariffs. Eurozone could be the unintended casualty

DAX’s choppy rebound could have completed at 12886.83, well ahead of the falling trend line resistance. As pointed out last week, the index is seen as bounded in consolidative trading in converging range since 13596.89. The close below 55 day EMA now puts near term focus back to lower trend line support (now at 12270). Break there will pave the w