The pound has had a steady week thus far, with GBP/USD marking slight gains along the way. As we go to press, we are now within earshot of the cycle top at 1.2640, which if broken, would represent a new one-month top for cable. Given the gains marked elsewhere for currencies against the dollar, you can’t help but wonder whether the pound would have fared much better if economic data had been more forgiving, combined with a somewhat less bumpy political ‘partygate’ landscape.
On the data front, the latest Services PMI was the one that caught the eye for all the wrong reasons. A nasty drop to 51.8 from 58.9, when markets had been expecting around 57.3, edges the survey towards potential contracting territory (if we move under 50.0). Manufacturing was a smidgeon better, ‘only’ slipping to 54.6 from 55.8.
That drop in the composite PMI points toward faltering demand, and highlights the squeeze on real household incomes, endorsing the growing projection that the UK will now fall into recession before the end of this year. Up until this release, the PMI readings had been holding up fairly well.
The government responded yesterday with another mini-budget, unveiling a much-disputed windfall tax on energy companies, as they try to address the massive increase to the cost-of-living. The £15bn package is designed to assist the UK consumer, given that there will be another big increase in energy bills come this autumn. The 25% ‘energy profit levy’ on oil and gas companies will also include a mechanism to incentivise investment. The levy should raise around £5bn of the total package, and will be phased out as prices normalise. Quite what normal is, we will have to wait and see. Moreover, quite what the energy companies decide to do with regard to future investments in the UK and such, is another matter.
Back to our beloved pound, and GBP/EUR remains trapped within a broad 1.1600 – 1.1900 range, with the pair encircling the centre spot of that range at present. Much like GBP/USD, perhaps one reason for the pound maintaining its composure is that the Bank of England seem determined to continue with their current programme of rate hikes, despite a weaker outlook, as they attempt to tackle that bulging 9% UK inflation level.
‘We will not be hiking rates in 2022’. Christine Lagarde’s comment at the end of last year reminds us of when Michael Fish said that there would not be a hurricane in the UK, the evening before the 1987 Great Storm caused £1.5 bn of damage, and took out six of the famous seven oaks.
In fairness to Madame Lagarde, inflation was only going to be transitory back in November (sorry Jerome), and with Euro-area countries now regularly occupying some of the top spots in the league of highest inflation for developed countries, the ECB needed a rethink.
However, that rethink has morphed over the past few weeks, with several ECB members now blatantly calling for a 50bps rate hike at the ECB meeting in July. ECB member, Robert Holzmann joined ranks with Klass Knot (he of last week 50 bps fame) to open the door to such a possibility. We are monitoring this particular development closely, as if this trickle turns into a flood of ECB members, then the chances of a big hike will get priced into market expectations.
Data has been giving a helping hand of late, with a stronger German IFO Survey and GDP. The latest PMI readings had something for everyone, but even where there was weakness, the declines were palatable. Looking ahead, next week is all about inflation again, and further increases are pencilled in, which could add weight to the 50bps camp.
In the meantime, the single currency has been marking consistent gains against the greenback, with EUR/USD moving as high as 1.0765 this week. That may not sound like much, but that has put us at a one-month top.
We highlighted the challenge for the greenback in our update last week. In particular, that weaker domestic data in the U.S is of concern to us, given the Fed’s intentions on rate hikes. The weak housing data last week (Housing Starts and Existing Home Sales), were joined this week by soft New and Pending Home Sales as well as weak Mortgage Applications. This is perhaps no surprise to many, given that long-term borrowing costs have risen so sharply, and so in many ways the Fed are achieving what they intended to happen with their rate hikes, as there is an obvious tightening of financial conditions.
But it is not just the housing market that is seeing short-term softness, with a 1.5% decline in GDP, worse than the 1.3% decline forecast. Durable Goods orders were also off, but that particular data set is about as reliable a data set as a 1970’s Cortina, so that will not stand-up too well as evidence.
Next week’s Consumer Confidence and April payrolls report will give markets more of an insight as to whether this trend of weakening data is more widespread throughout the economy. The latest FOMC minutes, which were released this Wednesday gave mention to this, and is perhaps one reason why the Fed want to Front-load and get as many big hikes in as possible, while they still can – which they also said. Market expectations still have 50bps priced in for June and July, but September has moved away from a dead-cert to a 50-50, which proves just how quickly markets will react to developments.
As for the dollar, well the recent decline also continued throughout this week, albeit at a more leisurely pace. As we go to press, the dollar index has now moved as low as 101.30. USD/JPY mirrored the move in the DXY, slipping back to 126.35 at one point, itself fuelled by a broader risk-off climate at times. In currencyland, both the JPY and CHF benefit from periods of risk aversion, reflected by USD/CHF moving back down under 0.9600.
The Loonie has had a much quieter week. This is perhaps due to there being only a trickle of domestic data and a fairly stable oil spot price (most of the time). On the data front, the latest Canadian Retail Sales were largely unchanged throughout March. There had been an expectation of a 1.4% increase, or 1.5% if you take away food and energy from the mix, so Cad-bulls were perhaps left a bit deflated by the headline.
By this morning, USD/CAD had still slipped back to 1.2750, which is tantalisingly near to a one-month low. The weaker greenback probably paid the biggest part in the move, but you could argue that a slightly stronger oil price also contributed at the margin.
Looking ahead, next week is all about the BoC. It is widely expected that they will hike rates by 50bps again, taking the overnight rate up to 1.5%. With markets fully pricing in such an outcome, the bit to watch is probably the BoC’s forward guidance. If they maintain a hawkish tone, then the Loonie could benefit, at least on the day, and given the relative strength of the Canadian economy (for now, at least), this is a likely scenario.
AUD & NZD
The RBNZ delivered another 50bps rate hike earlier this week, which takes rates in New Zealand up to 2%. They (RBNZ) are now forecasting a policy rate of between 3.25% – 3.5% by year end, and signalled a terminal rate* of 4% in 2023. That may sound somewhat hawkish at the long-end, especially given the chances of an economic slowdown at some point beforehand. In the near-term, we should perhaps expect the RBNZ to maintain its current 50bps hike trajectory for another couple of meetings.
Did NZD/USD rally because of the RBNZ? Well, not really. NZD/USD does continue to grind higher after reaching a low point just above 0.6200 earlier in the month, but the moves in the Kiwi are all about the greenback plus broader risk sentiment, with some worries over the Chinese economic output added to the mix.
As for the Aussie, well it has been a much quieter week. Similar to the Kiwi, AUD/USD is now back over 0.7000, but a distinct lack of keynote data has left markets with a temporary void in catalysts. Next week is a different story, with Q1 GDP and key trade numbers due.
*The terminal rate is the end rate, or the end of cycle rate.