25 November 2022

Thoughts from the dealing desk

-Joe Calnan, Manager – Corporate FX Dealing

GBP

GBP/USD reached an impressive three-month high at over 1.2150 this week, which seems incredulous really given the persistent negativity that seems to surround all things to do with the UK economy at the moment. Indeed, just this week we have seen the OECD place their projected outlook for the UK at the bottom of the growth list (again) amongst all G20 countries – barring Russia. At least we might outgrow someone. The latest economic data should have hardly encouraged a bull run on the pound either, with a rather sombre report released this week highlighting how UK public sector borrowing rose a whopping £13.5bn during October, roughly £4.4bn more than this time last year, as the measures to support households and businesses with their energy costs, start to eat into the government’s coffers.

On the plus side, there was at least a slight improvement over estimates in the latest S&P/Global PMI data, with the overall composite moving up from 48.2 to 48.3. That may sound modest, but analysts had pencilled in a decline to around 47.5, which could be a reflection that things are not quite as bad as they could be at the moment, even if only at the margin.

Gilt yields also continue to soften, which as well as giving the government some comfort, has helped to ensure that 5-year mortgage rates have now drifted back below 6% for the first time in over seven weeks. That may give something of a boost to the property market, although the BoE seem determined to raise UK rates further in their ongoing effort to tame inflation, so the boost may only be fleeting in nature.   

Back to the pound, and much of the move behind the strength in GBP/USD has been fuelled by the weakening dollar (see USD), but whilst the OECD may themselves be particularly negative on the UK, markets are far more sanguine and prepared to give Rishi Sunak and his chancellor some time to get their house in order, evidenced perhaps by the emerging strength of the broader pound, with GBP/EUR pushing sharply back over 1.1650. Looking ahead, next week is a quiet one for UK data, so the pound is likely to take its influence from the dollar side of the pond.  

EUR

Much the same as in the UK, this week has been a case of bad, but not as bad as it could have been amongst the key Euro area data releases. Although the latest PMI readings across the region highlight ongoing weakness and further signs of a slip into recession, all major components beat estimates, which may be an indication that the slowdown might not be as harsh as had previously been imagined. Furthermore, supply constraints are showing tentative signs of easing, notably in Germany. The latest German ZEW survey also beat estimates in two out of the three components (Business Climate & Expectations).

The size of the next ECB rate hike is still up for debate, with the ECB’s Robert Holzmann leaning toward another 75bps rate hike next month. Christine Lagarde suggested that the ECB will keep raising rates and may need to restrict growth, in their battle against surging inflation in the region, which should ensure that the ECB go for another bold hike, even if it is not quite at the level Holzmann would like to see. Next week’s region-wide harmonised CPI is expected to see another unwelcome jump from 5 to 5.2% (YoY). Markets are currently undecided on rates, with a clear split between 50 and 75bps, with the fate of inflation likely to tip the scales in one direction or another.

Interestingly enough, were the ECB to move at 75bps, and the Fed reduce to 50bps, we could see further upside adventures in EUR/USD as rate differentials start to move in favour of the single currency, despite the pair already surging back over 1.0400 during this week on that powerful combination of slightly better news, and the stuttering greenback.

USD

The holiday-thinned week has helped to ensure that markets have been fairly calm for once, with light volumes amongst major asset prices for the most part. The release of the latest FOMC minutes on Wednesday evening was probably the highlight for the US, and the two main themes we have come to understand from recent Fed speakers were clearly illustrated amongst the minutes. In case you missed them, they are; 1) that the terminal rate is now likely to be higher than markets thought it would be, and 2) most Fed members are in agreement that a smaller pace of future rate hikes is warranted, given the impact of those cumulative hikes so far. Markets were calmed by the dovish tilt from the Fed, and barring an unexpected surge in either the next inflation data, or the release of the November Labor report this time next week, a 50bps rate hike now looks a good call for the December meeting.

The rest of the US data this week has been a complete mixed-bag. The latest PMI report highlighted an unexpected weakness, with the flash composite dropping from 48.2 to 46.3. That represented the fifth straight monthly decline, with new orders dropping to a 2.5 year low and clearly impacted by rising interest rates and tightening financial conditions. Oddly enough, there was a surprising jump of 7.5% in new home sales, which looks very much like being a one-off. Durable goods orders also jumped 1% over the past month, but we gave up trying to estimate the outcome of those a long, long time ago.

As for the dollar, well the steady drive higher in risk assets throughout the week helped to ensure that the dollar index (DXY) did the complete opposite, sipping back to test the recent cycle low around 105.00. USD/JPY is now also comfortably back below 140.00. Looking ahead, next week will be dominated by the latest Labor report, with those recent heavy job cuts in the tech sector likely to have an increasing impact on the headline change over the coming months. Indeed, the latest estimates already expect a 30k decline through November.

CAD

Whilst inflation has come lower in Canada in recent months, we have yet to see a generalized decline in price pressures, so said BoC governor Tiff Macklem this week. Macklem went on to say that higher interest rates will still be required to cool the overheating economy. He also promised a thorough review of how all of the BoC’s tools worked, when challenged on what he (and the rest of the BoC) would have done differently to have avoided such high inflation in the first instance. He also said that this review would not be undertaken until inflation goes back under the BoC’s target of 2%, so that review might remain on the back-burner for a while.

Canadian headline inflation is currently steady at 6.9%, whilst core inflation is more of a mixed bag, which is often the case. Markets currently expect the BoC to hike rates by 25bps next month, with a less than 20% chance of a 50bps move.

Looking ahead, next week is key, seeing the release of the latest growth and employment data, with a flat monthly growth print expected, after the slight 0.1% gain in the previous month. After the impressive 108.3k gains in the previous Labor report, a much smaller gain is expected last month, when the data is released at the end of the week. Were there to be another blow-out, then the market-implied expectation for a bigger hike will no doubt increase.

The Loonie has remained fairly robust through the past week, with USD/CAD now trading within 100 pips of the recent cycle low of just over 1.3200, however, the greenback is once again the biggest influencer to the move lower for now.

AUD & NZD

As expected, the RBNZ made history this week in raising New Zealand rates by 75bps, pushing the official cash rate (OCR) up to a dizzy 4.25% in the process. The minutes of their meeting also implied that some members had called for a whopping 100bps hike. The RBNZ also suggested that the New Zealand economy may remain in a recession for a year or more, in order to bring inflation under control. With that in mind, they also see rates now peaking at 5.5%, compared with their previous, and rather dated forecast of 4.1%.

The Kiwi took its cues from the hawkish tones from the RBNZ this week, with NZD/USD surging to a new cycle high approaching 0.6300, with the move no doubt further fuelled by the softer greenback.  AUD/USD followed suit, but to a lesser extent, and still needs to break clearly through 0.6800, to confirm likely further upside gains. The latest Australian Retail Sales data (Monday) looks the pick of the bunch next week. Markets currently expect a decline from 0.6 to 0.3% (MoM/Oct).