Weekly Brief

Them’s the breaks

GBP

It has been a fairly dramatic week for the UK, with most of the attention being placed on the events culminating with Boris Johnson’s ultimate resignation, yesterday lunchtime. At times, the storyline was more akin to Coronation rather than Downing Street, but that slew of high-profile cabinet resignations, ultimately left Boris with less hope than the legendary Black Knight in Monty Python. Them’s the breaks, as Boris candidly said in his resignation speech.

Whilst Johnson will now remain as prime minister until his successor as leader of the Tory party is confirmed, from a market perspective the focus will now be on what sort of relationship the new leader is likely to have with the likes of the EU, and what policies they will push for in terms of reviving the economy, and dealing with those shocking increases to the cost of living. Johnson had been about to announce a range of tax cuts in an attempt to deal with some of those issues.

From a sterling perspective, well there was a mini bounce leading up to the resignation speech, which was probably being driven by the market thinking that all change is good change. GBP/USD rallied back over 1.2000 for a while, having been as low as 1.1875 and GBP/EUR moved back over 1.1800. Interestingly enough, the latter had the bigger move, and that is perhaps partly down to the single currency fighting its own battle against the dollar as it nears parity.

Looking into next week, there is a slew of keynote UK economic releases in the middle of the week, with Industrial & Manufacturing production as well as the latest trade Balance. The latter is growing in significance in the post-Brexit era, given the difficulties our exporters have been facing getting anything bigger than an ex-prime minister out of the building.

EUR

Confirmation of the ECB’s expected 25bps hike later this month has continued to trickle through from various members of the ECB throughout this week. We certainly can’t complain about their lack of forward guidance. Although we can never exactly rule out a bigger move, we think that the ECB are far more occupied with those increasing borrowing costs for the more indebted nations, than the surging inflation in the region. To that end, the weaker oil price (see CAD) might just help turn the tide. Next Wednesday’s German inflation print might be a little too early to see any impact just yet.

As we said above (see GBP), there has been a big focus within currency traders on EUR/USD, as it nears ever-closer to the dreamy world of parity. 1.000 may be a big psychological level, but it also plays an important role in currency markets, as it is often around these key psychological levels that option traders place large bets, so if nothing else, we should expect some fireworks around four months earlier than usual this year, if parity is tested. The last time that EUR/USD traded below parity was way back in 2002.

Aside from the stronger USD, the big increase in wholesale gas prices this week has also weighed on the single currency, given the challenging outlook for the region in the energy complex. The expanding interest rate differential between the U.S and EZ is also a big driver for EUR/USD specifically, as well as worries over an impending recession in the region. Time to dig your heals in Christine.

USD

For once, markets did not pay too much attention to the latest FOMC minutes, when they were released in the middle of the week. The feeling amongst markets was that things have moved on since the June meeting, and fears over a global recession have accelerated since that 75bps hike. Although the Fed are highly likely to make a similar hike later this month, there have been growing signs of weakness amongst the U.S consumer of late, and if this continues, September looks to be a whole lot more interesting.

Ahead of then, data-watching will be key, and one segment of the economy that has held up remarkably well has been the labor market. Whilst wage growth has not been able to keep up anywhere near inflation, and the overall participation rate is nowhere near as high as it should be at this point in the cycle, the steady headline growth has been impressive, unemployment has remained low and overall vacancies are outstripping those looking for work. With so much cash being given to American consumers in the COVID era, it will take time for them to burn their way through savings, which may be impacting decisions on whether the lower-earning half of the household need to look for full-time employment, or not.

Next week is all about inflation again, and the early predictions forecast a slight deterioration. Given the increasing worries over consumer spending habits, the latest retail Sales will also be closely monitored.

As for the greenback, well the dollar index rallied over 107.00 earlier in the week, but that move was all about risk aversion as opposed to Fed rate hikes. Indeed, USD/JPY slipped back from 136.50 to under 135.00 at the same time, which is a classic sign of broader market risk aversion, as opposed to broader market dollar strength. Looking ahead, interest rate differentials will still play a huge role in determining currency moves, and the dollar still has the upper hand on that front.

CAD

This week has been a classic one for evidencing just how closely commodity currencies follow commodity price movements. This is especially prevalent when those commodity prices are at a sensitive price point, such as oil has been of late. Oil dipped below $100bpl for both the spot price of Brent and WTI earlier in the week, with that move being driven by worries over a global recession, which would then negatively impact demand for oil. The Loonie slipped lower in tandem, with USD/CAD moving back over 1.3000 for the first time since the middle of June.

Interestingly enough, the pair failed to break over 1.3100 this week, much like the middle of June. However, oil prices had picked-up momentum again by Thursday, and that helped to ensure that USD/CAD was sent scurrying back below 1.3000.

Today’s (Friday) Canadian employment report is that last key release before next week’s BoC meeting. A slight reduction in the headline is expected from 39.8k to 22.5K, with the overall unemployment rate remaining around the 5.1% region.

It seems unlikely, however, that anything in the labor report will likely sway the BoC’s thinking next week, with most analysts homing in on a bumper 75bps move, given surging inflation in Canada, which would take Canadian interest rates up to 2.25%. Much like the U.S, Canada currently looks in a better place to withstand larger rate hikes, and we should expect the BoC to remain in hawkish mode going forward.

AUD & NZD

The RBA delivered another 50bps of rate hikes this week, hiking rates for a third month in a row. That marks an impressive 125bps worth of hikes since May, and represents the fastest pace of hikes from the RBA since 1994. Interestingly enough, the move did not really have a material impact on the Aussie, with AUD/USD unable to move above 0.6900 on the day. In fairness to the Aussie, the RBA hiked at the same time that markets were in a risk-off mode, so the greenback did what the greenback does at times like that. However, AUD/USD has traded at, but not below, 0.6760 on four occasions now, so it appears to have at least some short-term support. A sharp increase in the latest Australian Trade Balance may also be helping to underpin the Aussie, and with China likely announcing a big stimulus package this/next week, those Trade numbers could increase even further down the road.

Next week is all about the RBNZ, and whether they follow the likes of the RBA in another bold hike. So far, the RBNZ have lifted rates from 0.25% in August last year to 2% by the end of May. Markets certainly think so, pricing in a 50bps move. As well as the meeting, the RBNZ will also be releasing a statement of intent on Tuesday, which will outline the central bank’s three-year objectives, and should give some foresight into future moves on rates.

Thoughts from the dealing desk 

“With Boris Johnson accepting defeat yesterday, the Pound may finally see some gains in the short and medium term. The market sees this as an opportunity to turn the tide on Brexit relations with the EU, but much will depend on who is chosen as his successor. There remains two major issues for the UK that no budding Prime Minister is able to change – firstly: diverging interest rate policy with comparable economies, the EU and US; and secondly: inflation running high and GDP contracting, seemingly towards a recession next year. As a result, major banks are predicting GBP/USD to stay below the 1.20 level over the next four quarters. A particular stand-out prediction comes from Santander, expecting that GBP/EUR will be down at parity (1.00) in Q2 of 2023. And finally, EUR/USD continues to fall despite already being at 20-year lows. Currently sitting at 1.01, most are predicting that the two major currencies may cross the dreaded parity barrier within a matter of days for only the third time since the Euro’s inception.”

 - Joe Calnan, Corporate Dealing Manager

 

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