Investors do not seem keen in buying euro because they are worried about the political situation in Italy, the possibility of a recession in Germany, the prospect of aggressive easing from the European Central Bank and the ongoing risk of more tariffs from the US on Chinese goods. This week, Italy’s Prime Minister Conte resigned, turning crisis into chaos for the eurozone’s third largest economy. Of all the euro troubles, Italian politics has the most limited impact on the currency. Europe is no stranger to Italian political uncertainty (they just had elections in 2018 and who can forget Berlusconi’s countless scandals) and this crisis was a long time coming. Instead of rising, Italian bond yields fell because investors are hoping that the new government will be more pro-business. Talks have already begun to form a majority in parliament, which could hopefully pave the way for a smooth transition for Matteo Salvini, who is widely expected to become the new Prime Minister.
Recession on the other hand is a serious risk for Germany. According to the Bundesbank, Germany’s central bank, the country could very likely fall into a technical recession in the third quarter. Last week they predicted that GDP could continue to fall slightly. Growth has been weak for the past year as the country posted growth in only one out of the last four quarters. Unlike Italy, Germany is a serious problem for the eurozone. As the region’s largest economy, their slowdown will be felt across the continent. Although, it became evident last week that German and EZ PMIs rose in the month of August, the uptick in activity won’t stop the European Central Bank from easing. Industrial production is weak, investor sentiments are bearish and there’s a good chance that the upcoming German IFO business confidence index will decline as well. Auto sales have taken a big hit and fears of further tariffs along with a disorderly Brexit are mounting.
Just this past week, the US lawmakers urged the Trade Representative’s Office to hold off imposing new tariffs on European olive oil. In November, the Trump Administration will decide whether to impose duties on European autos. With all of these risks in mind, the European Central Bank will have no choice but to ease next month and they could deliver a bigger than expected stimulus package. This prospect will keep EURO/USD under pressure.
Meanwhile the US Federal Reserve is really going out of its way to downplay the need for easing. According to the FOMC minutes, most Fed officials saw the July rate cut as a mid-cycle adjustment and not the start of an aggressive easing program. Since then comments from policymakers such as Mester, Rosengren, George, Daly and Harker suggest that they may not support another rate cut. On Monday, Rosengren said the US is in a good spot right now and there is no need to take action if their outlook stays on track. He stressed that the Fed doesn’t have to ease simply because other countries are weak. On Tuesday, Daly said she supported the July cut but sees the labor market as strong and consumer spending. George seems to agree — she said just this morning that she’s not ready to provide more policy accommodation without seeing evidence of a slowdown. Like Rosengren, she described the economy as in a good place. Harker admitted that he reluctantly supported the July rate cut and felt that “we should stay here for a while, see how things play out.”
So while US President Donald Trump wants the Fed to be proactive and has taken every opportunity this week to lay on the pressure, US policymakers don’t seem to be onboard with the idea. If that’s true, it would be significantly misaligned with market expectations as Fed fund futures price in 100 percent chance of easing next month. Now it is all up to Fed Chairman Jerome Powell to clear the air. He is scheduled to talk on Friday and the tone of his speech could determine the direction for US dollar in the weeks ahead.