07 October 2022

GBP

Fortunately, it was a much calmer week for UK assets, after the highly volatile week that had preceded it. Absolute ranges for the pound and gilt yields were far more constrained, and the majority of news flow ensured that markets were far more sanguine on all things UK. Ahead of the Tory party conference, the government made the sudden decision to abandon their plans to scrap the highest rate of income tax, which is at 45p. Even though the saving to the government does not amount to much in real terms, the decision will have subdued many angry MPs within the conservative party, and it gave the government the opportunity to say that they had listened to the criticism of their mini-budget, during the keynote speeches from both the PM and Chancellor.

The Bank of England’s efforts to calm the gilt market have worked well thus far. Their allocated target of gilt purchases totalling £65B of up to £5bn per day for 13 days, looks like being nowhere near tested. The latest figures show that they have only had to buy a fraction of this amount to ensure that gilt yields remain anchored. It may well be that markets are waiting for the BoE to finish this operation before there is targeted selling again, but the mere presence of the BoE has been enough to calm markets. Sometimes it is what you say that you are going to do that is most powerful.

Sterling had quickly unwound all of the previous week’s declines by Monday morning, and having had a previous weekly range of 1.0300 to 1.1235, GBP/USD has spent most of this week gyrating between 1.1200 and 1.1500. Much of the rally for the pound has been driven by the weaker dollar. Although the announcement by credit rating agency Fitch that they have downgraded UK government debt from ‘stable’ to ‘negative’ has helped weigh on the pound since yesterday (Thursday).

Downgrades aside, now that the Tory party conference is behind us and markets have settled, the pound is likely to take much of its direction from incoming UK data, and there is plenty of that in store for this week, including the latest employment, Industrial and manufacturing Production. However, the broader dollar direction will always remain a major contributor. Calmer, but for how long?

Thoughts from the dealing desk

-Joe Calnan, Dealing Manager 

EUR

The latest batch of Euro area economic data continues to highlight how the region’s economy is weakening. Euro area Retail Sales dropped another 0.3% (MoM/Aug), with the yearly figure dropping by 2%, clearly highlighting how the increases to the cost of living are impacting the consumer’s spending habits. There were particularly large declines in both Germany (1.3%) and Holland (2.2%). The latest S&P Global Composite and Services PMI readings also reflected the overall contraction for the region’s economy, with both cementing their places below the key 50 threshold.

Whilst the data might be weak, the single currency pushed higher for a large portion of the week, evidencing the broadly weaker greenback. EUR/USD moved from a low of under 0.9600 at the end of September to tap parity, before slipping back under 0.9800 by yesterday’s (Thursday) close. The range of GBP/EUR was between 1.1324 – 1.1561, perhaps highlighting how this week has been as much about the dollar, as anything else.  

Looking ahead, next week’s German Inflation reading will be key, and having reached 10.9% (YoY/Sep), markets will be paying close attention to see if there have been any continued increases in inflation, especially given that we are approaching winter and the pressure put on the consumer through the ongoing energy crisis.

USD

Markets have been buoyed by a splattering of weaker than expected US economic data through this week, with both the latest JOLTS and ISM Manufacturing PMI readings both missing estimates. In the case of the former, the latest data highlighted that job openings had fallen to 10.1M during August. That is a sizeable drop of around 1M. The latest ISM Manufacturing PMI dipped to 50.9 from 52.8. However, the latest ISM Services PMI, which was released a few days after, was frustratingly better with a drop from 56.9 to 56.7 and much stronger than analyst expectations. With there being a long-standing gyration from manufacturing to services, the latter was probably the one that markets would have been most happy to see decline.

Notwithstanding this, there was a fantastic rally for risk assets throughout most of the week, with equity indexes making sharp advances across the board. Talk of a ‘Fed pivot’ was high amongst analyst commentaries. The ‘hope’ here is that the Fed will be incentivised to slow the pace of future rate hikes, given the slowdown in economic data. The flaw with this is that the Fed are solely focussed on inflation, and we will have to wait until next week for the latest CPI report. We know this by the relative plethora of Fed speakers waxing lyrical on a daily basis about this very subject. Even if there are signs of weakness across both the headline and core readings (on inflation), the Fed are unlikely to change tact on one inflation report, so the chances of markets being left frustrated at some point remain painfully high. It is the hope that kills you.

Later today (Friday) sees the release of the latest Nonfarm payrolls report (September). Markets expect another hefty 250K gains after last month’s 315k increase. At 208K, the ADP (private payrolls) just about beat estimates, highlighting the ongoing tightness in the Labor market, even if the JOLTS data has started to turn south.

As for the dollar, well the greenback has been the victim of that sharp rally in risk assets, with the dollar index (DXY) moving from a high of 114.70 down to 110.00, before finding some support throughout yesterday (Thursday), and moving back above 112.00. For the dollar rally to continue, in this good equals bad world, markets will need to feel disappointed with another strong labor report.

CAD

‘We have been pretty clear that interest rates need to continue to move up’ said BoC governor Tiff Macklem, just yesterday. In his latest keynote speech, Macklem also suggested that those increases to interest rates, and the regularity will be dependent on how underlying inflation and the broader economy evolve. Today’s September labor report might give us some clues, and given the unexpectedly weak report last month, there are hopes that Canadian employment can bounce back, with a 20k jump in the headline expected. Overall unemployment is expected to remain at, or close to, 5.4%.

The combination of the broadly weaker greenback, and the expectation that OPEC+ were going to cut production by a sizeable chunk, amounted to a decent rally for the Loonie in the early part of the week. USD/CAD dropped from over 1.3800, to around 1.3500. Perhaps it was a case of ‘buy the rumour, sell the fact’ because the Loonie struggled to make any further upside headway once OPEC announced their 2Mbpd cut.

AUD & NZD

Both the RBA and RBNZ raised interest rates as expected, earlier this week. The 25bps hike from the RBA was the most surprising, with markets firmly expecting a 50bps move from them. Whilst they (the RBA) highlighted that they will need to hike rates further down the road, they also pointed out that the ‘cash rate has been increased substantially in a short period of time’, given that they have now raised the cash rate to a nine-year high of 2.6%. Time to take their feet off the gas.

The RBNZ played to script, raising New Zealand interest rates by another 50bps to 3.5%, as they tackle surging inflation. That move puts Kiwi interest rates at a 7-year high. Perhaps the big surprise from the RBNZ was that they were even considering a bumper, 75bps rate hike, before settling on 50bps. Why not, everyone else is. In their accompanying statement, the RBNZ nodded to both super-high inflation and a particularly tight labor market. Where have we heard this line before?

Despite those rate hikes, both the AUD/USD and NZD/USD had a fairly sideways week in terms of ranges. AUD/USD moved as high as 0.6550, but has consistently found support between 0.6365-0.6400. NZD/USD briefly moved over 0.5800 for the first time in nearly two weeks, but slipped back below 0.5650 by yesterday (Thursday) afternoon. For both pairs to break higher, a broader greenback decline will likely need to be sustained.