Shifting expectations

View from the Trading Desk:

Taking a pause on today’s US Labour Day bank holiday, it’s worth noting just how much markets have moved in the past few weeks. In contrast to the traditional late-summer lull, we’ve seen every meaningful speech and data point pored over for clues as to future central bank policy action. Currency markets have been thrown into at least unfamiliar if not unprecedented territory as the trade-weighted US Dollar hovers around its strongest level in over two decades. Meanwhile, both Sterling and the Euro face their own headwinds, which are likely to cause significant pain points as we head towards Q4.

To highlight just how far expectations have shifted in the space of a month, and by way of explaining the recent bout of US Dollar strength, it’s worth looking at the change in the Implied US Policy Rate from the 1st to 31st of August (below). At July’s Federal Reserve meeting, Chairman Jerome Powell made a couple of comments that set markets on the path to predicting a pause or pivot in policy. He indicated the US central bank may have already reached neutral rates and that the Fed was committed to a ‘soft landing’ that would see limited economic woe in its quest to cool inflation. To that end, markets saw headline rates coming down below 3% by mid-2023. All too prematurely, asset prices rallied, and the US Dollar sold off.


Data: Bloomberg

By the end of August, however, markets predicted headline US rates sticking around 4% by mid-2023. In that time, the Pound fell nearly 8 cents lower on the US Dollar and remains over 16% down year-to-date. A slew of hawkish comments from Fed officials was capped by Powell’s Jackson Hole warning that US rates were heading higher for longer, even if that means inflicting some damage on the US economy. That, combined with existing geopolitical drivers, doesn’t bode well for both the Pound and Euro.

Bottom line: It’s not just a strong US Dollar that's contributed to Sterling’s journey below the $1.15 interbank level, and the Bank of England raising rates into stagflation is not to be considered a hawkish driver of the Pound. With three consecutive weeks of central bank policy decisions, September is probably going to be a very volatile month in FX markets; best strap in.

 

The week ahead

GBP 

In addition to the Monetary Policy Committee talks on Wednesday to address inflation and economic outlook, the announcement of new Conservative Party leader Liz Truss will likely be the main driver of Sterling performance this week. Truss will address the nation tomorrow from Downing Street and announce her cabinet before taking office. The Pound entered the new week near the lows seen in June against the Euro, but the new PM’s reported plans to cut taxes and grow the economy could see the British currency rally against its peers.

  • Tuesday will see the release of the Construction Purchasing Managers’ Index (PMI) for the UK. A contraction is forecast.
  • Monetary Policy Report hearings are due to take place on Wednesday, where policymakers will testify on inflation and the economic outlook in the UK.
  • On Friday morning, we’ll see the results of the Consumer Inflation Expectations Survey.

 

EUR

The Euro saw a short boost towards the end of last week after a new record-high Eurozone inflation level for July led investors to expect a large interest rate hike from the central bank during its meeting this Thursday. On Friday, the news broke from Russia that gas supplies would no longer flow through the Nord Stream 1 pipeline to the rest of Europe, refuelling fears of an unavoidable European gas shortage this winter. Unsurprisingly, following the news, the Euro tumbled over the weekend to the 0.9880 level against the US Dollar. All eyes will now turn to the European Central Bank this Thursday, with investor expectations torn between a 50 and 75 basis point hike.

  • The EU final Unemployment Change for Q2 is due for release on Wednesday, with a 0.3% increase in the number of employed people being predicted—similar to figures seen for Q1.
  • Also, on Wednesday, we’ll see the revised Gross Domestic Product q/q estimation for the second quarter of 2022 in the Eurozone.
  • The European Central Bank's Monetary Policy Statement will be released on Thursday, followed shortly by a press conference hosted by the ECB President and Vice President.

 

USD

The news out of Russia of halted Nord Stream pipeline gas flows sent the Euro to new lows for the year against the Greenback, with no obvious support levels in sight. Purchasing Managers’ Index data and Federal Reserve talks are likely to be the main talking points for the US this week. With little UK economic data being released, the Sterling to US Dollar exchange rate could slip to the Covid lows of 1.1412 if US data surpasses expectations and the scheduled Fed talks give hints of hawkishness.

  • On Tuesday, the Institute for Supply Management Services PMI is scheduled to be released, with an increase in industry size predicted.
  • Federal Open Market Committee (FOMC) members Loretta Mester and Lael Brainard are due to speak on Wednesday afternoon about the US economy and monetary policy, followed by Esther George and Christopher Waller on Friday.
  • US Unemployment figures are expected as usual on Thursday; a small increase is expected in the number of people who filed for unemployment insurance for the first time compared to the previous week.

 

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