30 September 2022

GBP

The past week has been something of a rollercoaster ride for UK asset prices, the pound, the government and Bank of England (BoE). It all started fairly calmly enough last Thursday, after the BoE announced an expected 50bps UK rate hike, and plans to begin the process of reducing their bulging balance sheet with an orderly selling of UK gilts (QT). The next day, the government announced in their mini-budget, an attempt to spur economic growth with aggressive tax cuts and massive borrowing plans, deliberately aimed at the top-end of the pay scale in order to generate a ‘trickle-down’ effect. The rest, as they say, is history, and has been colourfully documented around the world.

As we (and just about everyone else) have highlighted throughout this week, the measures from the government look like doing more harm than good for the UK economy. Indeed, the good people at the IMF said that if nothing else, the measures proposed by the government could rapidly increase UK inflation, at a time when central banks were actively trying to reduce it.

Markets quickly arrived at the same conclusion, and the pound and UK gilts came under intense selling pressure from the get-go on Monday. The yield on the UK 30-year gilt surged to around 5%, and GBP/USD dropped to its lowest level on record of around 1.0300, albeit in that particularly thin and choppy Asian Monday morning session.

With serious risks to both the UK pension and property markets, as well as the potential of a catastrophic impact to the broader economy, the BoE had little choice but to intervene, announcing plans to ditch their planned QT sales and instead start buying the long-end in clips of £5bn per day for 13 weekdays, with a package totalling around £65bn. The news sparked a spectacular reversal for gilt yields, which fell over 100bps on the day, which is a record for a single daily move. Although yields have moved slightly higher since, the presence of the BoE has ensured that those rises have been far more orderly. The BoE did the right thing by leaving sterling to the markets.

Going forward, markets still expect a very hefty rate rise from the BoE at their next meeting, and there remains much doubt as to whether the government’s programme will/can work, and whether the BoE’s intervention attempts will only delay the inevitable selling pressures down the line. Clearly, incoming UK economic data will be closely scrutinized by markets. In the meantime, the government have stood firmly behind their proposals, and the pound has since found some worthy support, with GBP/USD trading back over 1.1200 for a spell by this (Friday) morning, and GBP/EUR dancing its way back over 1.1375, having been under 1.0800 for a spell on Monday morning. These numbers look like ‘normal’ monthly ranges.

Perhaps more tellingly, the latest opinion polls are now giving Labour an historic 33-point lead over the Tories, whilst Liz truss is coming under mounting pressure from all sides to revise her plans. Interestingly enough, the latest UK growth figures have just been released this morning, and there was a pleasant upside surprise, with GDP increasing by 0.2% (QoQ/Q2), against an expected drop of about the same level.

Thoughts from the dealing desk

-Daniel Jones, Dealer 

EUR

The risk of a recession in Germany appears to be accelerating, with inflation having just risen to a 70-year high. German inflation reached double-digit levels for the first time since the 1950’s, with CPI tapping 10.9% (YoY) through September. The jump was perhaps no surprise, given that the range of government measures to limit prices on specific public services expired last month.

However, the impact of surging inflation in Germany is likely to push region-wide inflation to a new record level around 9.7%, when those figures are released later today (Friday). The news comes as Germany responded to the soaring rise in energy costs by announcing plans for a EUR 200bn cap on gas prices, which the Chancellor describes as a ‘defensive shield’.

Germany is satisfied that gas supplies will not run dry through this year and next, but the supply situation remains extremely tight, and the risk remains that were the country forced to ration supplies, there will be a dramatic impact on GDP through next year.

Given that inflation in the region continues to probe higher, the calls for another 75bps rate hike from the ECB at their next meeting have been increasing, with several key ECB members openly calling for an aggressive move again next month.

As for the single currency, well it has been a tale of two halves this week, with EUR/USD touching a new cycle low at 0.9535 on Wednesday before making a strong two-day recovery back toward 0.9800, rallying sharply alongside the other dollar crosses.  

Region-wide Retail Sales (Thurs) are probably the pick of the bunch into next week, as well as a slew of PMI readings.  

USD

The latest batch of US data did little to convince markets that the Fed have any reason to slow the pace of future rate hikes through this week. Consumer Confidence has just hit a five-month high, with the September reading reaching 114.00, up from 103.60 in August. Even parts of the housing market are showing unexpected strength, albeit New Home Sales, which rose 28.8% (MoM) over the month. Saying that, Pending Home Sales reverted to norm a day later, slipping another 2% on the month. There was also a 0.6% decline in GDP (Q2), but this is both a lagging and much revised indictor, so markets were more focussed on the latest initial jobless claims, which continue to reflect a tighter than tight labor market.

The latest round of Fed speakers also did little to suggest a change of heart from the Fed, with the Fed’s Evans highlighting how they (the Fed) need to address inflation. The day before, he said that the Fed will need to raise US rates by at least 1% more this year, and that they should reach their top Fed funds rate by March.

Next week is all about the September Nonfarm payrolls report, and given the ongoing tightness already evidenced, the 250k odd expected gains on the headline look entirely achievable. As always, we will monitor the overall Unemployment rate, as well as average Hourly Earnings and total Participation levels for any emerging signs of stress in the Labor force. Key PMIs are also scheduled for release through next week.

As for the dollar, well the last two days have resulted in a fairly big drop for the dollar index (DXY), which turned south after touching a cycle high at 114.71 on Wednesday, and by yesterday afternoon had slipped back under 112.00. The dollar has become very overbought recently, which may be a factor to the declines, but the trend for a stronger greenback still remains firmly in place, and with the Fed seemingly in no mood to take a less aggressive approach to dealing with inflation, the dollar remains by far the cleanest shirt in the dirty laundry basket for now.

CAD

It has been a quiet week on the data front in Canada, with the Loonie taking its directional bias from ongoing commodity price movements and the broader greenback for the most part. Overall, it has not been the best of weeks, with USD/CAD moving to a new cycle high at 1.3833, as the greenback continued to dominate across the board. Indeed, the Loonie has seen its deepest monthly decline since March 2020, with USD/CAD moving from under 1.3000 to that new high throughout the month. Not helping the Loonie has been the steady decline in the price of oil, which slipped under $80pbl for the first time in January.

Looking ahead, next week’s September Canadian employment report will be key. After last month’s surprising 39.7k drop, against an estimated gain of around 15k, those lofty BoC rate hikes could well already be negatively impacting the Labor market, so all eyes will be on this month’s release.

AUD & NZD

The latest Australian Retail Sales beat estimates, increasing by 0.6% (MoM/Aug), ahead of an expected gain of around 0.4%. The rise was driven primarily by increases in food related industries, with cafes, restaurants and takeaway services increasing. The resilience in consumer spending is likely to boost expectations that the RBA will raise rates in Australia by 50bps next week, potentially marking their fifth straight hike. That would put the cash rate up at 2.85%, and getting closer to marked-implied expectations, which have a year-end target of 3.4%.

With inflation in New Zealand refusing to back down in any hurry, the RBNZ also look like hiking rates by another 50bops at their meeting next week, taking New Zealand rates up to 3.5% in the process. This, despite many households seeing their fixed rate mortgage deals expiring, and having to refinance at the new, higher levels.

Both AUD/USD and NZD/USD sprung partial recoveries toward the latter part of the week, with the former moving back over 0.6500 and the latter forging a way back over 0.5700, having both traded at new cycle lows earlier in the week. With both the RBA and RBNZ meeting next week, we should perhaps also expect both to experience heightened volatility throughout the week.