Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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GBP: What can drive the next leg lower?
Charu Chanana
Chief Investment Strategist
Summary: Sterling is the worst performer on the G10 board against the US dollar month-to-date. Bank of England Deputy Governor Ramsden’s comments on Friday fuelled speculation that the UK central bank could be getting more comfortable with the inflation outlook and could cut rates by June. Market is still pricing only 60% chance of a rate cut by the BOE in June, which could see a dovish shift if PMIs come in below expectations or more BOE speakers turned dovish.
Last Friday, Bank of England’s Deputy Governor Dave Ramsden noted that the risks to UK’s inflation outlook were “tilts to the downside”, while also being “more confident” that inflation persistence is easing. This has fuelled speculation that the central bank may be starting to lean dovish in its stance on interest rates and could be laying the groundwork for a June rate cut.
The MPC’s February forecasts had suggested that UK inflation could fall briefly back to the 2% target in H1 before rising back to around 3% in H2. This led to the market pricing in an August rate cut for the BOE, assuming they would want to move after hitting the 2% inflation target. However, with indications that inflation could hit the 2% target earlier rather than later, there may be reasons for the market to re-assess what has been priced for the BOE rate curve.
As seen in the above chart, market is currently pricing in a 60% chance of a June rate cut from the BOE compared to a 70% chance of a rate cut from Bank of Canada in June and an 80% chance of a rate cut from the ECB in June. Ramsden also noted that UK CPI has fallen below the US and is converging with the Euro-area inflation, as shown in the chart below. If these trends were to be maintained, market will be aligning the expectations for BOE more to the ECB that is expected to cut rates in June, rather than the Fed.
Meanwhile, the Commodity Futures Trading Commission's (CFTC) weekly Commitments of Traders (COT) report showed that up until the week of April 19, the positioning in sterling is still net long despite a pullback in recent weeks.
This means GBP could be vulnerable in the coming weeks, and we would keep the following data and events on the radar.
- PMIs – Eurozone and UK activity surveys for April are scheduled for release today. UK composite PMI bottomed out in September and was rising until February which prompted an easing in recession fears. However, March composite PMI receded to 52.8 from 53.0 in February. While the index is still in expansionary territory, further drops could induce growth slowdown fears and prompt rate cut speculation.
- Dovish BOE comments – More BoE members will be on the wires today as well. Jonathen Haskel speaks at 0800 GMT and Chief Economist Huw Pill will be live at 1115 GMT. Both have previously signalled concerns over lingering inflationary pressures and any shift in the tone could be a key signal.
- Equity sentiment – Sterling has also shown high correlation to equity risk sentiment in recent times. After the sell-off on Friday in US technology stocks, sentiment is fragile heading into the big earnings week. Any further sell-offs in equity market could be a drag on GBP.
- US exceptionalism: Continued signs of US exceptionalism and inflationary pressures could be evident in the GDP and PCE reports out from the US this week. If further USD strength comes through, GBP could be more vulnerable than some of the other G10 currencies given its still-long positioning and scope for dovish repricing.
- Yen or yuan intervention: Any possible threat of intervention from Japan or China remains a significant risk for our bearish sterling view, especially if the intervention is coordinated and succeeds in turning the dollar lower more sustainably than past attempts.
Key levels to watch
GBPUSD tested the 1.23 handle on Monday but it was rejected. A break below 1.23 will bring the focus on 76.4% fibo retracement level at 1.2239.
GBPJPY continues to find support around the 50DMA at 190. March low of 188 remains in focus.
EURGBP has seen a sharp surge to cross over the 200DMA around 0.86 level. YTD high of 0.8683 in focus, and support at 0.86.
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