14 October 2022

GBP

It has been another tough week for all things UK. With both the government and the BoE saying that they intend to stick to their guns, this has resulted in some choppy price action, especially for the pound and UK gilts (again). In the case of the BoE, Andrew Bailey made it clear that the BoE intend to finish their programme of supporting the long-end of the yield curve by today (Friday). He also said that pension funds have had the time to get their collective acts together. However, in order to support flagging gilt prices, the BoE have had little choice but to spend big, with daily purchases approaching around £5bn by Thursday, resulting in a temporary daily increase of purchases from the BoE to £10bn. This is a big change from the small purchases they made at the beginning of the programme.

With the prosect of a ‘cliff edge’ scenario once the BoE finish their purchases later today, the government have been encouraged to make concessions on their tax cuts, in order to calm markets, and avoid further turmoil once markets re-open on Monday morning. Markets subsequently rallied on the ‘hope’ that Truss & Co will be persuaded to re-evaluate, with both the pound and gilt prices rallying sharpy on the headlines, ahead of the US inflation data (see USD).

Whilst Truss has already agreed to drop her plans to abolish the 45p tax rate, in a move that is unlikely to make too much difference in real monetary terms to the big picture, the latest concession is rumoured to be a plan to scrap the planned £18bn corporation tax cut. That is a much bigger number, and could well help to calm market nervousness, and take some more pressure off the pound. However, the discomfort from some within the Tory party has led to speculation that Truss and Kwarteng will need to rip-up almost all of the entire mini-budget to keep their jobs, in an effort to save the Tories flagging public support. As we said above, the mere rumour of big changes was enough to spark a rally in gilts, and send GBP/ USD back over 1.1375, a jump of over 2.5% on the session, which is a hugely impressive move on the day.

Aside from the politics and BoE, UK data has also been on the soft side, with weaker growth (-0.3%) and particularly soft Manufacturing and Industrial production, further highlighting the deteriorating economic outlook.

Thoughts from the dealing desk

-Oliver Taylor, Dealer

EUR

The latest economic data in the Euro area has not been too bad through this week. Granted, German inflation remains uncomfortably high at 10.9% (YoY/Sep), but there was no material decline beyond estimates in the latest report. Furthermore, region-wide industrial Production jumped 1.5% through August, well ahead of last month’s -2.3% reading, and way above expectations of around 0.6%.

Given the surging inflation in region, the talk amongst ECB members is of more aggressive rate hikes, with the uber-hawkish Klaas Knot suggesting on Wednesday that the ECB need a few more ‘significant’ rate hikes, before they reach neutral territory, but that the terminal (or final rate) is likely to be lower than that of the US. ECB president, Christine Lagarde, also said in a speech this week that the ECB have begun discussions on QT, even if she still believes that the most appropriate tool to fight inflation is interest rates, especially in this environment.

As for the single currency, the moves have been largely dictated by the other side of the pairing. Having jumped from around 1.0760 to back above 1.1500, GBP/EUR pushed to test muted resistance at 1.1600, but that was driven by the GBP side of the pair. Likewise, EUR/USD rallied from under 0.9650 to tap 0.9800 in a volatile session for the greenback yesterday afternoon.

USD

The latest US inflation report left markets in no doubt as to where the Fed are likely to be, come the next FOMC meeting. With energy prices trending lower throughout the summer, there was some hope that headline inflation may have eased through September, but that was not to be, with a monthly jump of 0.4% against an expected increase of around 0.4%. There was a slight improvement in the yearly figures, which dropped from 8.3 to 8.2%. However, the all-important core reading jumped by 0.6% (MoM), pushing the yearly print up to 6.6%. Market-implied expectations for future Fed hikes jumped on the data, with some analysts now expecting a bumper 100bps move from the Fed. Tellingly, those projections now also expect the Fed funds rate to be higher than 4.9%, by the middle of next year.

Core inflation remains the stickiest part, and it reached a new high for this cycle which is clearly frustratingly high, especially given the amount and frequency of Fed rate hikes throughout this year. Couple that with the ongoing robustness of the labor market, and any talk of an immediate Fed pivot look distinctly unlikely.

The market reaction was not a typical one-sided one we are used to seeing. We highlighted in our most recent daily comment that some of the biggest one-day down moves for markets this year have been on the back of inflation reports, and yesterday was quite an exception, with risk asses marking some big declines on the day, before an impressive bounce toward the end of the session. It had been particularly uncomfortable afternoon for US equities, but by the time that Europe closed for the day, there were strong gains across the board. I think we could call it a short squeeze.

Looking ahead, whilst other US economic data will matter to see any signs of stresses or emerging weakness, such as today’s Retail Sales data, given the Fed’s undivided commitment to bringing down inflation, the chances of bigger hikes for longer, have only been increased by the latest inflation data. The big winner of all that will clearly still remain the dollar. Just not yesterday.

CAD

With a lack of keynote Canadian data scheduled for release, it has been a far quieter week for the Loonie. With the OPEC meeting also behind us, the Loonie has taken its drivers from elsewhere. USD/CAD initially broke higher through the previous cycle top of around 1.3855, reaching a high of around 1.3977 yesterday, but the rapid reversal for the greenback, ensured that the pair accelerated back to the mid 1.3700 region. Quite an intra-day range.

Next week is a completely different kettle of fish, with both Canadian Retail Sales, and Inflation set for release. At 5.8%, inflation is still way too high for the BoC, however governor Macklem highlighted this week that the prices of a large basket of commodities, are starting to trend lower from their recent highs. Furthermore, supply bottlenecks have started to improve, which should also help to ease inflation.

AUD & NZD

Much the same as the other main dollar crosses, both the AUD and Kiwi made some strong advances yesterday, having both initially tapped new cycle lows. AUD/USD moved under 0.6200, before bouncing sharply to test 0.6300, and NZD/USD did the same having moved as low as 0.5512.

Next week is dominated by the latest Australian employment report. There was a strong bounce back after a disappointing release in the previous month, with a net rise of around 33.5K gains, and a total unemployment rate of 3.5%. Ahead of then, the latest RBA minutes are released, which will garner much market attention, given their surprise decision to raise by only 0.25% this time round, despite the cash rate now moving to a nine-year high at 2.6%.