Currently viewing the tag: "GBP/USD"
View: Economic weakness more of a risk for GBP than Gilts, like duration
The timing of Nigel Lawson’s observation that George Osborne should relinquish his role as chief Conservative chief party strategist to focus on the more important role of Chancellor has proved to be rather well timed with this morning’s first look at Q2 GDP showing the UK economy shrank at a dire -0.7% q/q rate, well below the median forecast of -0.3% q/q, leaving y/y growth at -0.8%. Ouch. The market was quick to seize on the positives, citing the Jubilee effect which most seem to think knocked 0.5% of the quarterly growth reading not to mention the rain which lasted a lot longer than that extended weekend. But this doesn’t alter the fact that the reading missed the median guess (who knew about the bank holiday and might have also looked out of the window at some point in Q2) by a significant margin and leaves us with three consecutive quarters of contraction in this double dip.
Full report below…
View: Break of DXY support significant, EM crosses look the most constructive option now
The break up in the dollar we saw during September looked a positive development for the greenback, but the pronounced failure of the key support area at 75.75/76.00 on Thursday was significant from a technical perspective and rules out any test higher in the immediate future. Indeed, the natural instinct of the market now should be to take the index to test down towards the 73.50 area which proved such solid support throughout June, July and August.
With bulls gaining confidence more widely, lured by hopes of a Santa rally, the obvious whipping boy is the USD. The Fed as ever remains firmly attached to dovish rhetoric, even if the widely anticipated ‘twist’ has only limited real impact, which will keep interest rate differentials blowing in a hostile direction – at least until the ECB cuts rates. It is also probably too early to become attached to the cyclical story with the downside risks to US growth substantial enough to offset what remains a dire picture for Europe (we’d stress the recent breakthrough on the debt crisis had nothing at all to do with fostering growth, if anything austerity focused policies in club Med and elsewhere have become even more closely linked to the support mechanism of the EFSF). This backdrop will probably be viewed as a success by the Fed, a weak dollar perceived to be one of the indicators that are supportive of recovery, alongside higher equity valuations. Bernanke has said as much.
In a world of ‘the least bad currency is king’ we’re left looking for more viable substitutes to be long. Despite the debt crisis solution in Europe we still find it difficult to come up with a constructive reason to buy the EUR and our gut still tells us to use rallies as an opportunity to sell, although we’d prefer to wait for a confirming technical sell from our indicators. GBP is being dragged along on the euro’s coat tails for the time being but we think this rally is poised to turn and would look to the first instalment of Q3 GDP due on November 1st as a potential trigger. There were plenty of disruptions in Q2 but any rebound is likely to be tepid. Median estimates see q/q growth at 0.3% and only one respondent in the Bloomberg survey is calling for a negative print. On a y/y basis the trend will slow further. Consumer confidence remains depressed thanks to a weak labour market and rising inflation, fiscal policy is also biting so the outlook for the fourth quarter is hardly inspiring too.
As we noted in our report yesterday though (http://wp.me/p1G1Fr-hk) the best opportunities in the FX arena appear to lie elsewhere, we like short USD/MXN for the time being while EUR/PLN and USD/ZAR also offer opportunities to bet on improved risk appetite lasting. The big macro bet of Asia currency appreciation took a big knock during the recent panic phase but the fundamental arguments for this remain solid too and the regional JPY crosses might also be a nice way of positioning for any BoJ intervention for an added kicker.
View: GBP/USD should struggle beyond 1.6100/40, watch for signs of a reversal
Sterling’s climb from the lows sub GBP/USD1.5300 touched at the start of the month has been quite impressive, the unit holding just under the 1.6000 level currently. Unfortunately this hasn’t been due to any particularly positive UK developments, rather the recovery has been on the coattails of a resurgent euro as investors piled in behind the view that policy makers there finally ‘get it’ and a credible solution was now in the works there. Of course such a scenario is essential for the UK too given that around half the country’s exports head for the single currency zone, but not enough in our view to warrant any substantial re-rating of the pound.
Examining UK dynamics more closely things are looking increasingly tough. Inflation hit 5.2% y/y in September (mkt 4.9%) and although nasty base effects were partly to blame it’s difficult to deny that there is a problem, underlined by rising inflation expectations, even if the headline rate does finally begin to moderate. This might normally be expected to help erode debt, but wage growth is paltry with the fall in living standards well documented and the unemployment rate is rising again, something not lost on the consumer with both the Nationwide (Sep reading 45.0 from 49.0 in Aug) and GfK (-30 vs. -31 in Aug) confidence survey’s stuck in the doldrums. It’s not just consumers though; the PMI’s showed manufacturing slipping into contraction over the summer while construction also continues to weaken. Only services have shown any resilience and the sustainability of that is questionable given income pressures and tightening fiscal policy. This should all be evident next week in the advance Q3 GDP print. Although NIESR estimates 0.4-0.5% growth recent performance and shocks over the summer (weather included) suggest this is optimistic.
Bank of England moves are equally telling, the additional dose of QE (increasing the programme from £200bn to £275bn) accompanied by cautious rhetoric as to the economic outlook, beyond here there have been calls for the government to show flexibility with regard to its fiscal consolidation. This was dismissed out of hand. It is after all the lone source of credibility left in the eyes of the market, even if the pledged budget targets look fantasy with the economy teetering. One metric worth keeping an eye on is the performance of gilts vs. bunds. While German paper outperformed amid flight to quality demand as the debt crisis flared, Deutschland’s credit worthiness is increasingly being called into question based on the assumption that they will have to bear a disproportionate cost of expanded bailouts. If we see UK yields begin to underperform vs. the German curve digesting this risk it might be an ominous sign. For reference 10-year spreads between the two sovereigns are currently +42bps from closer to 60bps at the start of the month.
The currency looks equally exposed, particularly given that economic performance may force the BoE to inject even larger quantities of cash into the economy via its inefficient QE channel. This should weigh on sterling, pressure that would become even more intense if markets begin to question the viability of the fiscal project too. The EUR/GBP chart still looks an uninspiring way to play this; however looking at cable we think the market will struggle to make much headway higher, the GBP/USD1.6100/40 area as really the very top of the recovery rally. Medium-term we continue to believe that GBP/USD should be able to push down through the September lows sub 1.5270 and would keep a close eye on indicators such as the MACD for sell signals. Even those with a more constructive view would be better served by patience, being room for even a short-term correction to tag back to the 1.5785 area if initial daily support at 1.5920/40 fails.
Related articles
- Mervyn King defends QE programme (independent.co.uk)
- Citi On Whether Europe Can Ruin The World; Or How To Use An Insolvent Continent As An Excuse For Global Printing (zerohedge.com)
View: Divergent BoE/ECB policy responses ironically have similar FX implications
You need to appreciate the problem to have a chance of solving it. The BoE’s decision to wind up its quantitative easing programme by a further GBP75bn today (from GBP200bn to GBP275bn) shows that policy makers in the UK are well aware of this, showing clear leadership in trying to counter the faltering recovery which the downward revisions to both Q1 and Q2 growth so clearly expose. This couldn’t contrast more sharply with the ECB’s approach, the decision this afternoon to leave rates on hold at 1.5% (by majority it appears based on the press conference) is just a demonstration of stubbornness and overshadows the other measures taken to alleviate liquidity pressures (such as the return of 12-month refinancing operations). We doubt a cut was simply delayed to help Mario Draghi kick off his term in office, although that may yet turnout to be the case!
Recession across the block looks more and more inevitable as fiscal retrenchment and the debt crisis continue to erode confidence and stress credit markets, the recent dip in commodity prices and favourable base effects remind of the very limited inflation risks – irrespective of the slightly higher September reading. The ECB seems to agree on the former (intensifying economic risks) but not on the other (inflation risks balanced). In our view there is a compelling case to cut rates immediately. Delay merely compounds the problem. What a poor note for Trichet to go out on after eight years at the helm.
FX market impact ironically should be rather similar. The second dose of QE in the UK is a clear fundamental negative for sterling, which is no doubt part of the solution in the BoE’s mind, improving export competitiveness and thus the economy. The immediate drop in GBP/USD highlights this, the first reaction taking the cross to new multi-month lows. Indeed, the cross is down 8.1% from the August highs thus far. A close under the key 1.5340/60 support area would switch the focus to 1.5000 in the short-term and on more extended timeframe would suggest a push on towards 1.4300 – where the cross based out last June – could be possible.
While the ECB’s tighter policy looks good from a rates perspective the impact the decision should have on the Eurozone economy will hold the real sway on markets. There had been fairly broad hopes that the ECB would cut today, failure to deliver such positive news will merely reinforce fears for the region and maintain stresses on the troubled periphery. By pushing the ECB behind the curve it is likely a more aggressive policy response will be required. Ergo the EUR has been punished and will continue to be punished until policy makers and governments adopt more practical strategies. Technical charts support this fundamental view with a push towards EUR/USD1.3000 and from there the January lows at 1.2900/1.2867 being the immediate objective, although this probably won’t be sufficient to net off the damage imposed by the ECB’s obstinacy. Only a swing back through 1.3700 would temper downside momentum now, which looks rather unlikely. Our core view remains that we are still in the earlier stages of the EUR decline.
Related articles
- Europe’s Banker Fights for His Legacy (online.wsj.com)
- Jean-Claude Trichet to leave ECB with bigger, riskier role (telegraph.co.uk)
