06 April 2023

GBP

Things did not bode well for the UK leading into this winter. We had just had a change of government, after the brief and ill-fated Liz Truss era. Forget the likes of the IMF, the outlook was so dim that BoE were even telling us that the UK might be about to enter into a seven quarter long recession. How times have changed since. The pound now proudly holds the title of the best performing currency, amongst G10 currencies so far this year. Strategists now remain ‘cautiously optimistic’, which is a world away from being constantly pessimistic. Impressive indeed.

In a way the negative outlook has played into the hands of the pound. What does that mean? Well, when the outlook for a country looks so bleak, economic analysts will naturally revise down expectations for economic growth, which can then subsequently make it easier for countries to beat those estimates. We call it the economic surprise index (ESI). Set the bar low, and everyone can jump over it, so to speak.

Amongst those beats, positive GDP growth will clearly take the majority of the headlines, given the BoE’s dire outlook. However, there have been notable improvements amongst sentiment as well as a robust labour market throughout. With much stronger than expected tax revenues and less outlay for the government in relation to their ongoing energy support schemes, the improving fiscal position is also helping to attract international investor flows. Add into the mix the fact that UK Banks have so far dodged the recent banking wobbles, then it is perhaps no surprise to see why the pound continues to be boosted.

The BoE may also be aiding the rally in the pound. With core UK inflation recently rising from 5.8 to 6.2%, the BoE remain committed to the prospect of further rate rises, even after the recent 25bps move. GBP/USD is also benefitting from that broadly weaker dollar of late, which has helped the pair rally to a 10-month high at over 1.2500 earlier this week. GBP/EUR moved back over 1.1450 earlier in the week, perhaps confirming broad-based sterling strength. A sterling performance indeed.

Thoughts from the dealing desk

This commentary does not constitute financial advice

-Louis Kolliari, Corporate FX Dealer

EUR

It has been a fairly solid week amongst key European data over the past week. The latest ISM Services PMI data was somewhat mixed, with beats for the likes of Italy and Spain, although Germany, France and Regional data missed. However, the data crucially remains in expansionary territory, which bodes well for future economic output.

The latest Factory Orders and Industrial Production data out of Germany also beat by some margin, with the former expanding by around 4.8% over the latest month, and the latter witnessing a 2% increase. There have also been a respectable 7.3% increase amongst New Orders in the capital goods sector, representing the third increase in a row.

The single currency has also had a fairly solid week, with EUR/USD rising ever-closer to the key 1.1000 psychological region, albeit at a more measured pace. Looking ahead, next week will be dominated by inflation data for the likes of Spain and Germany, which could have an impact on the short-term profile for the single currency.

USD

Incoming data throughout this week, has led to increased expectations that the plethora of rate hikes from the FOMC, may be finally having a widespread negative impact on the US economy. Whilst the likes of the housing market have shown clear and ongoing signs of stress for a while now, as borrowers react to surging long-term interest rates, the Labor market has remained impressively resilient throughout.

That resilience looks like it may finally be starting to wear a little thin. Granted, we still need confirmation from the key nonfarm payrolls data, which is released tomorrow (Friday). However, both the JOLTS and ADP reports which preceded the payroll data this week, missed expectations by worthy margins. In the case of JOLTS – which tracks ongoing job vacancies, available positions dropped below the 10M level for the first time in two years. Of course, two years ago was back in the pandemic lockdown era, when the world was in a completely different place. The monthly decline of 632,000 vacancies from the previous month is also key, as it may be reflecting a sharp drop in business sentiment.

Less than a day later, the latest ADP (private payrolls) also disappointed, with March witnessing a mere 145K gains versus an expected increase of over 260K, reflecting considerably slower growth for the private sector. Around the same time, the latest ISM Services PMI data also reflected marked slowdowns in New Orders and Prices Paid, with the overall PMI falling to 51.2 last month, down from 55.1 in February. That weaker data follows on from visible softening amongst key inflation in the US of late.

Markets are therefore becoming ever-more convinced that the Fed will move to an immediate pause, after raising US rates to a target range of 4.75-5% in just over a year. Indeed, market-implied expectations for that outcome (pause) at the Fed’s next meeting, which is at the beginning of May, have risen from around 40% to over 60% throughout this week, fuelled largely by the softer data. If tomorrow’s payrolls deliver a similar negative result, expect markets to then fully price in a pause. The Fed will then need to follow suit or make the market aware that they are prepared to carry on hiking with updated forward guidance. The weakness amongst data has also naturally increased fears that the US will slip into a more marked slowdown or even a recession, at some point later this year.

Looking ahead, next week will be dominated by the latest US inflation data, coupled with the minutes of the last Fed meeting, during which Jay Powell admitted that the FOMC openly discussed pausing rate hikes, given the accelerating banking wobbles at the time. As for the dollar, the recent downtrend has continued unabated, with the dollar index slipping by around 0.7% so far this week*, a move which might be expected to continue with any ongoing softness amongst key US data.

*As of Thursday

CAD

The week started off in fine style for the Loonie bulls out there, with OPEC+ making surprising oil production cuts that totalled around 1.16 million barrels per day. That news ensured that the price of oil surged by over 6% on Monday, which led to another push higher amongst commodity currencies, such as the Loonie. USD/CAD quickly descended to just over 1.3400 at one point, having been as high as 1.3800 on the 24^th March.

Aside from a bounce in the price of oil and that broadly weakening greenback, recent Canadian data have also helped to boost the Loonie, given that it increases the probability that the BoC might be inclined to take their feet off the brake pedal and raise Canadian interest rates once more, after their recent pause. On that note, both GDP and Retail Sales have been higher than expected.

The latest Labor data, which came out a day earlier than normal due to the easter holidays, will also remind the BoC of ongoing robustness, given that unemployment remains at a healthy 5% and the overall Net Change in Employment grew by 34.7K, having been expected to have jumped by around 12K over the past month.

AUD & NZD

There were some big surprises from both the RBA and RBNZ at their most recent policy meetings earlier in the week. In the case of the RBA, they decided against hiking Australian rates, instead leaving the policy rate at 3.6% after 10 consecutive rate hikes. Whilst the RBA did warn that ‘some further tightening of monetary may well be needed’ – in a bid to ensure that inflation heads back towards the RBA’s target, they also wanted time to assess the cumulative impact of their recent hikes on the Australian economy.

The RBNZ may have been an even bigger surprise to markets, given that they decided to raise New Zealand rates by another 50bps, just a day later. That takes NZ rates to a 14-year high of 5.25%. In their accompanying statement, the RBNZ said that inflation was still too high and persistent and they have not excluded further rate hikes if needs be.

Having risen in the early part of the week from around 0.6650 to just under 0.6800, AUD/USD gave back all of its gains. NZD/USD did the same, rising from 0.6210 to nearly 0.6400 on that hawkish RBNZ move, but then slipping back to within a whisker of Monday’s open by Thursday afternoon. Next week is dominated by the latest Australian employment report, with overall unemployment expected to remain near to the 3.5% region.