President Trump's assault on the Fed rattles markets

The stabilisation of the US dollar hit an air pocket last week after reports suggested that President Trump was on the cusp of firing Fed chair Powell.

While it is far from clear that Trump would have the power to do so, the market's reaction was swift and brutal, and for a few minutes we saw a reprise of the "sell America" trade that shook the world back in April: stocks, bonds and the dollar were sold off mercilessly. Once again, the ferocious market reaction forced the Trump administration to backtrack and Trump himself issued a hurried denial that any such move was imminent. While the market rebounded just as swiftly, and the dollar actually managed to end the week modestly up against most of its peers, the episode was a reminder of both the risks that Trumpian chaos presents to markets, and the key role the latter are playing in restraining the president's chaotic impulses.

Now that the issue of Federal Reserve leadership is hopefully put to rest for the time being, market focus should shift back to the unpredictable trade and tariff headlines, as the clock ticks towards the 1st August deadline set by Trump. Beyond that, Thursday looks set to be an unusually volatile day. In addition to the ECB July meeting, the PMIs will be published in all of the main economic areas. In addition, a slew of second tier data everywhere will help us confirm or reject the economic narratives that have been developing: US resilience, steady but sluggish activity in the Eurozone, and a worrisome slowdown in the UK.

GBP

Data out of the UK last week carried a distinct stagflationary whiff. Inflation surprised to the upside, in particular the more stable core subindex. Services inflation remains stuck near 5%. Unemployment ticked up, and the number of payrolled employees fell for the fifth consecutive month, albeit the enormous drop of the month prior was revised upwards. This contrasting news puts the Bank of England in an extremely tough spot. While we still expect the MPC to lower rates again at the August meeting, the recent uptrend in UK inflation means that the bank is likely to strike a cautious note that indicates further cuts will remain very gradual.

The downbeat data of the last few weeks is reflected in the slow grind downward of sterling against the euro, while it keeps holding up well against the dollar. The silver lining for the UK is that the PMIs have been performing better than the lagging real data so far. This week’s release therefore takes on added importance.

EUR

The European Central Bank is expected to hold rates unchanged at its July meeting this Thursday. The meeting itself will probably be largely a non-event, as there will be no updated staff projections, and the communications from President Lagarde will remain as non-committal as possible. We expect the Governing Council to provide little guidance for the future, instead leaving its options open.

With the cutting cycle largely complete, attention turns to the trade war with the US. Markets are ratcheting up their expectations of the level of tariffs that the US will levy on European goods slowly, as trade talks seem to be making slow progress and we are getting closer to the 1st August deadline. The July PMIs are expected to once again show sluggish growth, just sufficient to keep the economy near full employment.

USD

Beyond the Powell headlines, the US economy continues to show resilience even as the first hints of the tariff impact appear in the inflation numbers. Retail sales, weekly jobless claims and industrial production all came in higher than expected last week. While inflation numbers did not deviate much from expectations, core goods inflation firmed up somewhat, in a hint of tariff pass through, as the positive impact of pre-tariff stockpiling fades.

Full employment, healthy demand growth, a massive fiscal deficit and firm inflation are not consistent with easier policy. We expect the Fed to resist pressure from Trump and keep rates unchanged next week. There is also very little pressure on the FOMC to signal that cuts are imminent either. Markets continue to hold a September cut as the baseline scenario, but last week’s solid data has very much put this view in doubt, which partly boosted the dollar against almost every other currency last week.