Sterling, euro gain as dollar dips

The US dollar sank yesterday for no readily identifiable reason, but perhaps on a bit of position squaring as China’s currency strengthened and ahead of today’s European Central bank and Bank of England event risks. Hope that we are finally winding our way to a Brexit deal has helped both the euro and sterling, though as we have discussed recently, uncertainties remain. We are hopeful as well and suspect high probability that something gets done ahead of the mid-November EU summit, but would prefer to express a view through options – for example, EURGBP put spreads rather than in what could be a very volatile spot market any time the UK political situation appears at risk of derailing the progress toward a deal.

The EU has taken the unprecedented step of voting to censure Hungary for its move away from EU guiding principles like the rule of law. Hungary’s Prime Minister Orban won elections in a landslide earlier this year and has promised a thorough review and change to the country’s constitution, which has already been revised once under his leadership and included changes that weakened the judiciary and the independence of the press. The forint was sharply lower in these latest developments, but the weaker USD yesterday saw nearly all emerging currencies putting in a strong performance. The row between the EU and Hungary is a long-standing one and it would only be at the point that real sanctions against Hungary’s behaviour threaten capital flows and foreign direct investment that  a more profound move in the currency is a risk. Nonetheless, it all adds to the noise on the EU existential risks, the CEE/core fault-line, and whether the far larger Poland continues to copy Hungary’s governing model.

The Turkish central bank is set to announce rates today, with widespread expectation for a 300+ basis point hike of the key repo rate, taking the rate to 21%. The TRY has managed an extended bout of stability and a softer US dollar yesterday was wind at EM currencies’ back. That rate meeting today looks like a litmus test for investor confidence in the more fragile EM currencies.

Former dove and now hawk Lael Brainard of the Federal Reserve Board of Governors delivered a rather hawkish speech yesterday in which she more directly indicated that an inverted yield curve would not prevent the Fed from hiking rates and didn’t necessarily mean that a recession is imminent. She indicated that the Fed rate hike cycle could extend over the next year or two. If she is right, and the Fed continues the every other meeting pattern for, say, 18 months, including two the two hikes later this month and in December, the Fed Funds terminal rate will be above 3.5% in early 2020. A speech from Brainard some months ago already indicated in rather indirect language that longer rates might be excessively low for reasons dissimilar to the past, indicating a lack of concern about yield curve inversion already then. Fed rate expectations have pulled to the highest for the cycle, but this speech was no fresh catalyst.

The Fed’s Beige Book, meanwhile, was also released last night and was a mixed bag, with many of those surveyed enjoying strong current conditions but fretting new trade tariffs and implications for input costs. 

Up today we have an ECB meeting at which the ECB will roll out its latest forecasts. The lack of apparent inflationary pressures has many looking for a dovish spin in the forecasts, although the forward guidance on tapering and an eventual rate hike after next summer are not likely to see major shifts. Hard to see this meeting as major catalyst. The Bank of England is mostly a formality and I don’t see the need for Carney and company to send any further signals at this point. In the US, the CPI release today is the key data point for the week.

Chart: EURUSD

We have laid out our thesis that the recent powerful rejection of the run below 1.1500 was a bullish development, but subsequently, the implications of that reversal have been watered down by the amount of time that the pair has been stuck in neutral, meaning bullish conviction has ebbed again. Traders looking for a bigger move may have to sit on their hands here, with the downside level more clearly etched around 1.1500, while the upside levels are bit hazier, arguably a pivot zone of 1.1750-1.1800 needing to be cleared to launch EURUSD on a run to 1.2000 and higher again. Today’s ECB meeting and US CPI releases are a great tactical test of whether traders can gin up any conviction.