11 November 2022

GBP

It has been another solid week for the UK, with the pound surging to new 2-month highs against the wilting dollar. Rishi Sunak and his government continue to make the right noises, with this week even seeing apparent progress on the much-fretted Northern Ireland protocol. Pictures of a smiling Ursula Von der Leyen sat next to Rishi Sunak as they discussed NI at COP27, at least confirmed that they get on, which is a great place to start.

UK economic data has not quite justified Rishi’s smiles, with the latest Halifax House price data slipping 0.4% (MoM/Oct) and taking the yearly figure to an increase of 8.3% versus 9.8% in the previous month. Clearly those BoE rate hikes are starting to negatively impact the outlook for the UK property market, and further declines look probable, given those big increases in mortgage rates across the board, notwithstanding the efforts by the BoE’s Bailey to bring down yields at the long-end of the curve.

The broader growth picture comes into play today, with the latest UK GDP report. Last month, the UK narrowly avoided negative growth (up 0.2%), but this month there was a slight decline of 0.2%, and although that was better than prior estimates of -0.4%, the news clearly highlights the tricky challenge ahead for the BoE. Whilst they (the BoE) would like to continue hiking rates until there is a material decline in inflation, that task becomes ever more challenging once a recession kicks in, and the chances of that are high in the UK given the obvious slowdown in economic activity.

Looking ahead, next week is key for the UK, with the latest Retail Sales, Employment and inflation data scheduled for release. Headline inflation is currently expected to increase from 10.1% (YoY) to about 10.3%. As we said at the top, it has been a good week for the pound too, with GBP/USD moving back over 1.1700 for the first time since early September, and GBP/EUR bouncing back over 1.1500, having slipped below 1.1400 earlier in the week

Thoughts from the dealing desk

-Joe Calnan, Corporate Manager

EUR

Other than the US inflation data (see USD), there was also some better news for markets to digest out of Europe this week, after the latest German Industrial Production (IP) data had a surprising burst to the upside. IP unexpectedly increased by 0.6% (MoM), comfortably beating estimates of an 0.2% increase. Interestingly enough, production in ‘energy-intensive’ industrial branches actually declined by 0.9% throughout September. Despite the good headline, Destatis*, did warn that the ‘extreme shortage’ of intermediate products and supply-chain logistics was still a headwind on IP.

There was also some better news to be had on the Retail Sales front, with Euro area Retail Sales increasing by 0.4% through September, up from a flat reading previously, and helping to reduce the yearly decline from -1.4% to -0.6%. Amongst the data, there were some strong monthly gains for food, drinks and tobacco components, with a sharp drop in fuel sales throughout the region. Amongst the member states, Austria had the best month, with sales increasing by nearly 4%.

The news will bring some comfort to Christine Lagarde and the rest of the ECB, who face the tricky challenge of making further bold rate hikes, despite weakening economies throughout the region. Indeed, ECB head Lagarde highlighted again this week the need for the ECB to continue to raise Euro area rates, even if there has been an increased probability of a recession. Lagarde said that ‘We are determined to do what is necessary to bring inflation back to our 2% target.’ Euro area inflation is currently above 10%. Talking of inflation, today sees the release of the latest German Harmonized CPI, which is expected to have remained steady at around 11.6% (YoY/Oct). Next week will be all about regional inflation and growth.

As for the fate of the single currency, well EUR/USD has now clearly broken back above the 1.0200 resistance region, which had previously capped the topside for the Euro against the greenback since the summer. This gives strong support to the theory that the single currency might be making a more sustained recovery against the recently-beleaguered greenback, with a strengthening currency also lending a supporting hand to the ECB’s battle against surging inflation.

*Destatis are the German federal statistic authority

USD

The latest US inflation report gave markets a real shot in the arm on its release yesterday (Thursday). The annual pace of CPI slowed to 7.7% during October, down from 8.2% in September. The monthly jump of 0.4% was softer than the 0.6% figure expected. Take the key Food and Energy components out of the mix, and the core numbers also came in well under estimates, being 0.3% (MoM) versus 0.5% estimated, and 6.3% (YoY) versus 6.5% expected.

Markets rejoiced on the news, with US equity indexes surging by some margin in the immediate aftermath, as risk assets soared across the board. The Nasdaq rallied by nearly 6% in a flash. Whilst it may have represented only one month’s worth of data, market-implied expectations for future FOMC rate hikes were also quickly revised lower on the news, resulting in a far less probability of 75bps hike than had previously been priced into markets.

The news came out right after the Democrats made a much better than expected showing in the mid-term elections, and although the Republicans may have taken the House, the Senate battle rolls on, with several key states still to call. Joe Biden will certainly have had a better week, and he was quick to suggest that he will be prepared to run for a second term. Donald Trump had suggested that he was about to make a big announcement next week, but after a mixed showing from his endorsed candidates in the election, he may be reconsidering that.

As for the greenback, well as you will know by now, the dollar will always struggle in a risk on day, and yesterday we had risk on in abundance. The dollar index quickly dropped to below 108.00, a level not tested since early September. The greenback lost its way against a myriad of currencies on the day, but USD/JPY really caught our eye, slipping over 4% on the session from over 147.00 to just over 140.00. The BoJ sure must have enjoyed their Thursday evening. The conversations around whether the dollar has reached its peak in this cycle have also naturally now been increasing of late, and whilst it is too early to get carried away on one inflation print, markets will respond in a positive fashion to even the slightest chance of the Fed hiking by smaller amounts, which the CPI report could have helped to solidify.

Looking ahead, next week’s Retail Sales will be closely monitored to see to what degree the US consumer has been impacted by those Fed rate hikes. In the meantime, the dollar might struggle some more in this climate.

CAD

Aside from the mixed-bag of a US employment report last Friday, at the same time and somewhat under the radar, the latest Canadian employment report was released. To say that the report was a ‘blow out’ is probably an understatement, given that job gains beat estimates by 10 times, with nearly 110K new roles filled throughout October. That helped to bring the overall unemployment rate down from 5.3 to 5.2%. Healthy increases in the overall participation rate as well as a decent upswing in Average Hourly Wages, further highlighted strength in the labor market.

In response to the surging employment data, the Bank of Canada suggested that Canada would be able to weather any impending economic decline, without seeing a major surge in unemployment. Whilst the BoC have also recently suggested that they are coming to the end of their aggressive series of rates hikes, which has seen them hike by 350bps since March, further smaller hikes still look like the order of the day. Next week’s inflation data will likely have a big impact on market-implied expectations from the BoC, with the latest estimates suggesting that an increase in the key yearly core reading from 6 to around 6.3%.

As for the Loonie, well USD/CAD has declined from near 1.4000 to under 1.3350 throughout this week, and whilst the US inflation data played a key role in the move, market confidence in the Loonie has been further boosted by that strong Canadian labor market.

AUD & NZD

Both the Aussie and Kiwi benefitted strongly from that softer US inflation report yesterday (Thursday), with AUD/USD moving back above 0.6600 for the first time in two months, and NZD/USD breaking over the psychological 0.6000 region at the same time. Aside from USD/JPY, the (over 2%) rallies for both the AUD & NZD were amongst the biggest against the greenback for developed currencies on the session, and point toward potential further gains now that key resistance regions have been eroded.

In other developments, RBA deputy governor Bullock said that Australian inflation is set to peak soon, and perhaps as early as Christmas, although by that time inflation may reach a record of around 8%. Bullock said that ‘While our inflation forecasts have been revised up a little, there are good reasons to think that we are approaching the peak of inflation this cycle.’ Bullock also blamed much of the increase to inflation on Russia’s invasion of Ukraine. The RBA have been under intense pressures domestically for not talking surging inflation earlier, even though the country lags behind the likes of the US, UK and Euro area.

Looking ahead, next week’s Australian Employment report will be key, with the latest estimates predicting a slight increase in the overall unemployment rate from 3.5 to 3.6%. In New Zealand, key data releases are on the thin side next week, with only the latest PPI data on the agenda.