Macro: Sandcastle economics
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FX Update: Waiting out the complacency for what comes next…
John J. Hardy
Head of FX Strategy
Summary: We have a very complacent market in a very illiquid trading month. The market appears to be pricing a gentle landing, with commodities back on the defensive and the US dollar aimless ahead of the latest jobs report today. Yesterday saw the largest Bank of England hike in 27 years, with the Bank of England forecasting a nasty and prolonged recession, and yet UK yields are almost unchanged after intraday churning yesterday.
FX Trading focus: Waiting out the complacency. Bank of England goes dire – UK yields shrug.
The Bank of England issued perhaps the most remarkably dire outlooks for an economy ever at its meeting yesterday, suggesting that inflation will peak at 13% later this year as the UK economy is set to dip into a prolonged recession starting in Q4 of this year and extending through the next calendar year. Yields traded all over the place in the wake of the expected 50 basis point hike, the largest in 27 years, as the market tried to draw implications on whether the BoE would continue moving in 50 basis point increments over the next couple of meetings, given the pessimistic outlook. In the end, the market decided that the incoming inflation forecast will keep the hurdle high for any BoE downshift and the market retained expectations for more large hikes to come, with 45 bps prices for September and another 41 bps for November. By the end of the day, Governor Bailey managed to convince that the bank is forced to forge ahead to get inflationary risks under control despite the gathering clouds and continued to note the risks of an inflationary spiral becoming “embedded” in the economy. The balance sheet reduction plan announced yesterday is at the more aggressive end of the £50-100 billion/year range at £80 billion. Sterling now has to trade on sentiment as opposed to rate spreads – any rapid deterioration in sentiment could see the pound looking vulnerable again versus USD and perhaps CHF, and even JPY if yields remain subdued.
Chart: EURUSD
The USD was mixed yesterday, staying firm against commodity currencies as the recent slide in crude oil prices suggests a market gearing up for recession risks. After an intraday rally, the USD was pushed back lower against the EUR and JPY as soft US weekly claims kept US yield tames and complacent risk sentiment continues to hold back the dollar. If the US jobs data solidifies the view that the US labor market is softening and pushes yields lower, the greenback may see an intensification of this pattern, with USDJPY particularly yield-sensitive and EURUSD possibly squeezing into a flurry of stops, likely above 1.0300. A far stronger than expected jobs report together with a considerable upside surprise in the average hourly earnings data in particular could see the USD broadly stronger. EURUSD needs to resolve one way or another soon after nearly three weeks in the 1.0100-1.0275+ range. Further out, the dire energy/power situation as Europe looks forward to the risk of a dark winter and power cuts, potentially to whole swathes of its economy, will likely keep a lid on an EUR upside ambitions beyond a positioning adjustment.
Elsewhere, the feeling across markets is one of low-energy complacency, rather remarkable given the menu of forward risks in Europe on power shortages and globally on China tensions (see free eurointelligence.com stories on the front page today on possible new cold-war like lines drawing up as a major concern, although I don't share all of the historical parallels/lessons). Zooming into today’s US jobs data, the most interesting test of the market narrative today and in coming US jobs/earnings reports, would be earnings growth that remains elevated in a still-tight jobs market and continues to drive stubbornly high inflation, not to mention the inflation readings themselves (Important: US July CPI is up next Wednesday). As noted in today’s Saxo Market Call podcast, the Atlanta Fed median wage measure touched a strong new high in June at 6.7%, even as the average hourly earnings series has stagnated around the 5.0% area on a moving average basis. But the more important driver here is whether the data challenges the market backdrop – it seems the only thing that can, given that clear, coordinated pushback from the Fed to discourage the market’s forward policy expectations failed to even register since the FOMC meeting.
Table: FX Board of G10 and CNH trend evolution and strength.
The downdraft in the commodity currencies is perhaps the most consistent momentum shift of note as we await the reaction to US jobs data today (and CPI data next Wednesday!), though gold is challenging above an interesting level versus the US dollar today (1,780) and has posted the largest momentum advance over the last five days in our universe.
Table: FX Board Trend Scoreboard for individual pairs.
Waiting for whether USD pairs get a spark from today’s data, there is no strong signal, which has picked up a bit more for sterling and the commodity currencies. In the case of sterling, EURGBP needs to vault well clear of 0.8450 to look a bit more determinedly directional. JPY pairs should be sensitive to any US yield move on the back of the data today and CPI next Wednesday.
Upcoming Economic Calendar Highlights (all times GMT)
- 1115 – UK Bank of England Chief Economist Pill to speak
- 1230 – Canada Jul. Employment Data
- 1230 – US Jul. Change in Nonfarm Payrolls
- 1230 – US Jul. Change in Nonfarm Payrolls
- 1230 – US Jul. Average Hourly Earnings
- 1400 – Canada Jul. Ivey PMI
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