The European Central Bank kept its deposit facility rate unchanged at 2.25% at the July 23 meeting. The Governing Council kept its options open, maintaining a data-dependent, meeting-by-meeting approach without precommitting to a rate path. However, the market is pricing in an 89.5% probability of a hike in September due to the reversal of Middle East risks, which upended the balanced growth-and-inflation scenario the ECB stated at its Sintra Forum at the start of the month.
ECB President Christine Lagarde said that the mild scenario now looks unlikely due to the widening conflict in the Gulf, citing a Houthi Red Sea tanker attack as a prime example. While the ECB has yet to see any second-round effects, noting the gradual decline in wage growth, it is detecting indirect effects. Lagarde added that ECB staff will follow up with an analysis of oil and gas at the September meeting.
However, EUR/USD broke below 1.14, closing lower by 0.3% at 1.1377. The ECB’s hawkish pivot was neutralized by those for the Fed. With Brent crude prices rising above $100 per barrel, markets priced in a 71.9% probability of a Fed hike in September, up from 46.6% a week ago. Fed Chairman Kevin Warsh will likely keep his priority on price stability at next week’s FOMC meeting. However, he could hint about advancing his goal to end forward guidance by ending the dots and Summary of Economic Projections at the September meeting. To convince markets of a new downtrend, EUR/USD needs to break sustainably below this month’s consolidation between 1.1360 and 1.1480.
Adding a layer of complexity to the global macroeconomic landscape is President Donald Trump’s announcement to impose tariffs of up to 12.5% on 60 major US trading partners. Theoretically, higher oil prices and higher tariffs should increase the USD’s haven appeal. However, FX markets are not displaying the same kind of panic seen immediately after Liberation Day and Operation Epic Fury.
This muted reaction could come down to how Wall Street categorizes and prices these two global risks. Tariffs are seen as a high-stakes negotiating tactic that leads Trump to TACO (Trump Always Chickens Out), i.e., eventually delay or soften them to avoid a market meltdown. The Gulf conflict’s reality is NACHO (Not a Chance Hormuz Opens) or a geopolitical gridlock that keeps the critical waterways and oil supply blocked. Conspiracy theorists will likely see the Trump administration pairing these twin risks to get allies and rivals to turn to the US, now the world’s largest LNG exporter and top oil supplier, for their energy needs.
Best to stay nimble for now.
Quote of the Day
“Well, by the standards of a lot of countries, by Latin American standards, it (US inflation) wasn't so bad.”
Paul Volcker
July 24 in history
President Jimmy Carter named Paul Volcker as Chairman of the Federal Reserve in 1979. Volcker was most famous for dramatically raising interest rates to crush the hyperinflation of the late 1970s and early 1980s.
Topic
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