European markets traded cautiously yesterday ahead of this week’s Federal Reserve rate meeting, as investors hedge their bets ahead of what is likely to be a pivotal moment in terms of future US rate expectations over the course of the rest of this year.

While President Trump, as well as his chief economic advisor Larry Kudlow have been more than vocal in urging the Federal Reserve to cut rates this year, the latest economic data out of the US doesn’t really support that sort of radical action.

The foreign exchange market and the bond markets appear to be offering different perceptions of what the Fed might do tomorrow, and in this context, it won’t be what the Fed does that is important, it will be what the Fed says with respect to its guidance on future monetary policy.

If FX markets are correct, the rise in the US dollar suggests that the Fed won’t be anywhere near as dovish as investors expect, while bond markets appear to be pricing in the prospect of at least two rate cuts this year, with the first one as soon as July.

With all the focus on the Federal Reserve it’s easy to forget that the European Central Bank is facing an even bigger problem. With ECB President Mario Draghi leaving at the end of October, and the economy in Europe floundering, today’s speech in Sintra, Portugal at the ECB central bank forum, could offer further clues as to how much further the ECB can look at monetary easing, over and above the September TLTRO program.

As the problems of Deutsche Bank starkly illustrate, the negative interest rate environment is doing enormous damage to European banks ability to generate any sort of profit margin on its everyday activities. With inflation once again sliding back close to 1% in May, markets are slowly coming to the conclusion that the ECB is operating at the limits of what it can actually do by way of conventional monetary policy.

Today’s final EU CPI numbers for May are expected to be confirmed at 1.2%, a one year low, and a sharp drop from April’s 1.7%, while core prices sank back to 0.8% from 1.3%.

The pound has continued to come under pressure, hitting a five-month low against the euro yesterday, ahead of tonight’s Conservative party leadership hustings event, which is due to be televised on the BBC later this evening. Boris Johnson still remains the bookies favourite, barring any sort of mishap, though this evenings event could act as a potential banana skin.

Bank of England governor Mark Carney will also be speaking in Sintra later this afternoon, though he will very likely to be constrained by what he can say about domestic policy due to Thursday’s Bank of England rate decision.

Crude oil prices have continued to shrug off concerns over rising geopolitical tension between the US and Iran, sinking back over concerns about future demand, and slowing economic activity.

Even a commitment from the Saudi energy minister that OPEC remained committed to extending production cuts, and the news that the US is sending 1,000 more troops to the region, in what could be the beginning of a serious escalation, has failed to lift prices significantly.

EURUSD – found some support at the 1.1200 area, however continues to look weak, and could well slip further towards the May lows down near 1.1110. We need to see a rebound back above the 1.1270 area to stabilise and retarget the 200-day MA at 1. 1370.

GBPUSD – approaching support at the 1.2550 area and the lows at the end of last month. A move through 1.2550 argues for a move back towards the low this year at 1.2430. The 1.2760/70 area remains the primary resistance level, and the main obstacle to further gains.

EURGBP – has broken above last week’s tweezer top at 0.8930 with the potential to move higher towards last year’s highs above 0.9020. Having rallied for 7 weeks in a row, we’re on course for week 8 while above the 0.8900 level. For now, we’re finding support at the 0.8870 area, with the 200-day MA at 0.8780 below that the main support, and is likely to contain any dips.

USDJPY – having found support at the 107.70/80 area we’ve edged back higher but need to push back through the 108.80 area to retarget a move to the 109.20/30 area. Bias remains to the downside and the 106.00 area, while below the 109.20 area.

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