Currency markets waiting for fresh direction

Today's news headlines:

  • 'MPs vote to seize control of Brexit’. MPs will now participate in a series of indicative votes to try and find a way forward for Brexit. However, the government has made no promises to implement what politicians agree on, and the EU is warning a no-deal outcome looks increasingly likely. (Financial Times)
  • 'Fed rate cut seen nearer as yield curves invert’. The performance of US Treasuries is now fast approaching the point where the Federal Reserve has previously cut interest rates in a bid to stave off recession. (Reuters)

Brexit

Despite another defeat for the UK government in Parliament last night—politicians from both sides of the house were vying for control of a new Brexit direction—the Pound has held broadly steady. Even suggestions from the European Union that the risk of the UK crashing out of the trading bloc was continuing to rise has been insufficient to unsettle Sterling. The economic performance of other developed market economies isn’t exactly robust either, so the Pound isn’t much worse off than other major currencies right now.

Why the yield curve could drive US rates

On Friday, the difference between yields on three-month and ten-year US government debt ‘inverted’ for the first time in over a decade. Typically, the yield on longer-dated US government debt is higher than that on the shorter-dated equivalents, but heading into a recession, demand for longer-dated debt increases, pushing the yield lower. In other words, investors are willing to take a lower return for the same level of risk, and with the US economy slowing, this measure has been in focus of late.

The difference in yields between the two-year and five-year bond is also seen as a key forward-looking indicator. This reached nine basis point (0.09%) on Friday, and historically, the Federal Reserve has been quick to cut interest rates when the difference exceeds 12 basis points. The last time the Fed failed to act swiftly was in the 2006 inversion, ahead of the Global Financial Crisis. Therefore, expectations are building that a US rate cut may be near, and that’s something which would have the potential to weaken the US Dollar.

GBP/USD

The Pound has been trading sideways against the US Dollar as markets await fresh direction for both currencies. Any renewed optimism over Brexit could see Sterling supported in the near-term.

EUR/USD

Again, there has been little direction for the Euro against the US Dollar so far this week, although mounting speculation that the Fed may need to act quickly on interest rates could provide some upside here.

GBP/EUR

Brexit uncertainty has left the Pound facing increased levels of volatility against the Euro, although again, there’s little overall direction here. Any indication that the UK can avoid a no-deal outcome has the potential to support the Pound.