Brexit remains a large cloud looming over the UK economy, making it difficult to assess underlying trends. Despite strong economic fundamentals, monetary policy has been on hold since August 2018. Gross Domestic Product (GDP) growth is relatively high, employment and wage growth are strong, and inflation is near the Bank of England’s (BoE) target. In fact, it was previously noted that a neat Brexit outcome might result in interest rate hikes. Yesterday’s UK Manufacturing and Industrial Production figures were disappointing to say the least, the largest declines since 2002 and 2012 respectively. The market reaction was nearly non-existent; the trade-weighted Pound Index barely moved which suggests yesterday’s poor data points have been attributed to an unwinding of Brexit stockpiling. Rather surprisingly, the Bank of England’s Michael Saunders struck a hawkish tone in his speech yesterday evening. Seemingly unphased, he expects excess demand in the coming months and warned of delaying interest rates hikes.
Bottom line: Today’s labour market data has confirmed the underlying employment and wage growth picture. Therefore, support for Sterling could be expected, since UK interest rate hikes haven't been priced in.
At the start of this quarter, the dominant market theme and hotly debated topic in financial media was the potential for continued equity appreciation. Following a roller-coaster drop in December of 2018, where the S&P 500 fell 15% in three weeks, the stimulative impact of the Trump tax cuts resulted in a rebound of 25% in the following four months. By the end of April, equity markets had reached all-time highs once again. At that time, gradual monetary policy tightening throughout developed markets was reasonably expected to curtail excessive asset valuations. In fact, it was the political and economic uncertainty during May which resulted in a moderation of equity prices, but the setup for fresh appreciation was already developing behind the scenes. Since the start of June, three Fed speakers, including Fed Chairman Powell, have communicated a truly dovish tone, as opposed to the neutral stance during the so-called Fed pivot back in March. Also, Brent crude’s rise and fall has neatly coincided with equity prices, and isn’t expected to appreciate in the coming months, lending further support to global growth. This decidedly market-friendly backdrop sets the scene for a more extreme asset appreciation and potential a raft of new problems.
Bottom line: The S&P 500 is only 2.0% off the top once again, and it seems there’s more to come. It’s also entirely possible that markets have overestimated the Feds capacity for policy loosening, particularly when the communication seems to have worked so well already. With Mexican tariffs seemly out of the frame, the mood seems to be improving and may negate the need for Fed policy action altogether
The Pound Index traded relatively flat yesterday, losing just over 0.5% of its value despite a terrible set of data releases. Today’s average earnings report and accompanying labour data will dictate the Pound’s movement after remaining stuck near the bottom of its trade-weighted range.
The common currency has been a prime benefactor of softening trade tensions as the Euro Index has moved almost 1.5% higher since late May. There’s certainly room for it to start targeting trade-weighted levels last seen in December 2018, pushing the cross lower.
Markets are more optimistic about trade and this has been evident in the upside momentum for the pair. All in all, the signs point towards more gains, and EUR/USD has comfortably crossed the 50 and 100-day moving averages. Meanwhile, Goldman Sachs has upped its three-month forecast from 1.10 to 1.15.