September 25, 2018 / 7:30 AM / 20 days ago

Daily Briefing: Dollar power thwarts Europe on Iran

LONDON (Reuters) - Ahead of speeches by Donald Trump and Iranian President Hassan Rouhani at the U.N. General Assembly, Europe is setting out today a last-ditch effort to keep business going with Iran in the face of U.S. sanctions.

People dressed as Iran's Supreme Leader Ayatollah Ali Khamenei and Iranian President Hassan Rouhani protest on the street against Iran in New York, September 24, 2018

But in reality the decision by Trump to pull out of the 2015 Iranian nuclear deal, the jewel in the crown of recent European diplomacy, has been a sobering demonstration of Europe’s weakness and the continued might of the dollar.

Those sanctions have prompted European majors such as Peugeot, Deutsche Telekom and Airbus to withdraw from Iran, depriving Iran of the promised economic benefits of curtailing its nuclear programme.

The so-called “special purpose vehicle” announced by the EU earlier today is essentially a barter system to exchange Iranian oil for European goods without money changing hands. But no one is under any illusions that this will be the game-changer for the Iranian economy that moderates like Rouhani need to justify the 2015 deal at home.

Back in Brussels, the talk now is how to reinforce the international standing of the euro in the event of future trade stand-offs; but such an ambition could take years to fulfill, even assuming it is more than just a pipe dream.

The UK opposition Labour Party's struggle for clarity on Brexit continues. As party delegates gear up to debate policy in Liverpool today, its Brexit spokesman Keir Starmer has just said it could back a second referendum giving voters the option of staying in the EU.

That flatly contradicts what the party’s powerful economy chief John McDonnell said yesterday. Today the party is supposed to agree a motion establishing its policy on a second referendum; there could be some twists and turns in the hours ahead.

The German news agenda will likely be dominated by the shocking revelations at a bishops’ conference today of decades of sexual abuse of children by Catholic priests. The sheer scale - more than 3,600 cases involving 1,670 priests according to leaked excerpts - call for a major examination of how such crimes were allowed to happen and raise more profound questions about the role of the church in Germany.

MARKETS AT 0655 GMT

While many were watching the latest twist in the Sino-U.S. trade war, world markets have switched more squarely to concerns about central bank tightening this week.

With the Federal Reserve widely expected to hike interest rates for the third time this year on Wednesday, European Central Bank chief Draghi on Monday cranked up the case for starting to normalise ECB policy over the coming year by referring to ‘relatively vigorous’ underlying inflation and brisk wage growth.

Sweets with names based on politically themed puns and word games are seen for sale at the Labour Party's conference in Liverpool, September 24, 2018

European bond yields jumped on the comments, with 10-year German bund yields extending those gains to 4-month highs of 0.529 percent early on Tuesday. Euro/dollar briefly popped above $1.18 and even though it lost most of its gains later in the day, it’s nudging higher again this morning to $1.1755.

"Iran will lose sizeable export volumes, and given OPEC+ reluctance to raise output, the market is ill-equipped to fill the supply gap"

This week’s surge in Brent crude oil prices to near 4 year highs above $81.69 per barrel early on Tuesday will only embolden both central banks. Oil prices have been buoyed as U.S. sanctions on Iranian crude exports near and after top exporters Saudi Arabia and Russia dismissed calls from U.S. President Trump to boost output and keep a lid on energy prices. Some energy analysts now think a rise in crude back to $100 is possible.

With rising trade barriers seen lifting producer and consumer prices at the margin too, the case for stepping up monetary tightening is being watched closely in bond markets everywhere. Ten-year U.S. Treasury yields climbed above 3.1 percent for the first time in more than four months earlier too.

The net effect of tighter money, higher energy costs and rising trade barriers is also dragging on equity markets as they watch the negative fallout on growth. The S&P500 fell back 0.3 percent overnight, with the Dow Jones industrials underperforming with a loss of 0.7 percent.

After a loss of almost 1 percent on Monday, MSCI’s emerging market equity benchmark was down another 0.2 percent earlier. Returning from Monday’s public holiday, Shanghai stocks were down 0.5 percent, even though the offshore yuan firmed slightly.

China’s Vice Commerce Minister said on Tuesday it was difficult for Sino-U.S. trade talks to proceed with the United States putting "a knife to China's neck" after both sides imposed new tariffs on each other’s goods on Monday.

A weaker yen helped Tokyo’s Nikkei outperform and it ended in the black after Bank of Japan chief Kuroda said it will take longer than expected for the central bank there to reach its inflation goals. Aside from the euro, the dollar was a touch stronger more generally and the DXY index was a shade higher.

Emerging market currencies have steadied this week with the dollar on the backfoot, with Russia’s rouble getting an added boost on Monday from the oil price surge and India’s rupee underperforming.

Turkey’s lira also added to Monday’s 2 percent jump after U.S. Secretary of State Mike Pompeo said he expected talks with Turkish officials over the fate of U.S. pastor Brunson, whose trial in Turkey has strained trade and diplomatic relations with Washington.

Unnerved by rising bond yields and trade anxiety, European stocks are expected to open lower. Italy’s 10-year government borrowing spread over Germany’s narrowed 7 basis points to 238 in early trade, meantime, after government sources said the ruling coalition was willing to keep the annual budget deficit below 2 percent when it presents plans later this week.

Sterling was steady to a touch lower after some big swings on Brexit speculation over the past week. The Brexit spokesman for the UK’s main opposition Labour Party said on Tuesday the party will keep open the option of a second Brexit referendum with a question wide enough to include the option of remaining in the European Union.

— A look at the day ahead from European Economics and Politics Editor Mark John and EMEA markets editor Mike Dolan. The views expressed are their own —

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