Head of FX Strategy
Summary: The sterling freefall from Friday continued in Asian hours overnight, crashing through its all-time low versus the US dollar at one point in awe-inducing downward spiral that suggests extremely poor liquidity and lack of confidence in the currency. The Bank of England will need to move quickly to shore up the situation, but does it have the leadership to do so? Elsewhere, the downside pressure on the JPY is building again as the USD and US yields rise.
FX Trading focus: Historic drop for sterling
Sterling’s downward spiral continued apace overnight after the Friday tax cut announcements from UK Chancellor Kwarteng sparked a landslide in the currency. I scratched my head early on Friday at the market not reacting more negatively and punishing sterling on the Bank of England’s mere 50 basis point hike on Thursday. Now I can see with perfect hindsight that for some reason the market was waiting for the crystallization of what is knew was coming all along: new tax cuts that will be a further disaster for the public balance sheet, with double-up pressure from the even larger and already announced energy subsidies continuing to drive yawning trade deficits. A bit surprised that the market wasn’t pricing more of this in before the fact, but in the end, the aggregate direction of UK policy and the BoE’s slow response justifies the price.
Now the Bank of England has its work cut out for it if it wants to stabilize inflation as inflation expectations and outcomes will have marched that much higher after a 10% drop in sterling’s trade-weighted value in a matter of few weeks. The policy rate expectations are already rising above 4.25% for the November 3 BoE meeting, with some of that pricing reflecting the view that the BoE will have to move between meetings and impress the market if it wants sterling to stabilize. Governor Bailey seems poorly equipped to deal with the task ahead, but the BoE will need to deliver. As for GBP – the magnitude and sharpness of the move since Friday may have to do with poor liquidity more than the absolute magnitude of Chancellor Kwarteng’s new announced tax cuts, but downside risks continue if sentiment and poor liquidity worsen further globally. Note EURGBP already having gone full circle from 0.8930 at the Friday close up to 0.9200+ overnight and then back near 0.8930 as of this writing.
Chart: GBPUSD
An historic couple of sessions in the bag for sterling, which dropped to record lows overnight below the 1985 low point of 1.0520. This may or may not mark a major cycle low for the near term and has a better chance of doing so if US yields finally ease off (market crash risks rising every day that US yields continue spiking higher) and if the Bank of England delivers a stern message on doing whatever it takes to defend the currency. Resistance is now around 1.0800 (the spot that triggered a gappy avalanche overnight and then not until 1.1200. The obvious next psychological and round number is parity. The situation is fluid – as “the Bank of England is expected to make a statement today.”
The latest weekly Swiss National Bank sight deposit data sent an interesting signal in that the SNB’s holdings actually dropped, and by the most since it created these sight deposits as a means to fight CHF strength. The last time there was a significant drop in the deposits was just before and especially after the SNB’s surprise June rate hike that set in motion the significant CHF rally that took EURCHF from 1.0400 to well below parity in a few short weeks. Falling sight deposits suggest that the SNB is happy to buy CHF and sell foreign FX to keep the CHF on the stronger side of where it would otherwise trade. Perhaps the SNB would like to mix in some heavy reserve management to fight inflation with intervention and unwinding a portion of its gargantuan reserves rather than tracking the panicky pace of policy tightening elsewhere? The overnight action in EURCHF looks more linked with sterling’s woes, but USDCHF is trading up at interesting levels, clearing the range highs since July and eyeing parity soon after pulling above 0.9900 this morning.
Let’s have a look at the US 2-year treasury auction later today. For savers, shorter dated treasuries offer significant yield now, of course only really attractive if inflation moderates, but the current 4.25% yield offers solid yield and little duration risk. The last auction on August 23 saw middling demand when the 2-year yield was about 100 basis points lower.
And let’s also have a look at how China responds to USDCNH hitting new all-time highs above 7.20 after trading as high as 7.168 today. But the most pressure in Asia is on USDJPY after a Kuroda speech today brought nothing new to the table other than his justification for intervention. Don’t look now, but USDJPY is pulling back well above 144.00 in today’s trade. After all, US yields are trading well above their levels when USDJPY first nearly hit 145 more than two weeks ago (key US 10-year benchmark then was some fifty basis point below the current 3.78%. Expect the market to challenge the BoJ/MoF soon if yields stay up here or higher.
Italy’s election saw little market response and the right parties performed a bit weaker than the polls in aggregate at 43%, even if coming PM Giorgia Meloni’s Brothers of Italy party did well at 25% of the popular vote. The vote total does not offer an overwhelming mandate. As the new administration finds its feet, one key angle will be whether Meloni succeeds in rolling back some of the reform measures passed by Draghi as she has vowed to do. These reforms were part of the terms for Italy accessing the eventual EU pandemic recovery budget of EUR 200 billion for the country.
Table: FX Board of G10 and CNH trend evolution and strength.
The USD strength reading is getting to unsustainable levels beyond the nearest term with its current reading above 8, but given the connection with spiraling sentiment, could yet end in a further climax before reversing. GBP is in a deep funk now, falling at a rate that will likely elicit a BoE response soon. NOK is also very weak on the Norges Bank’s curiously dovish guidance and crude oil prices getting pummeled.
Table: FX Board Trend Scoreboard for individual pairs.
Note NOKSEK staying negative even after the recent spike and now falling to key chart areas again down into 1.0500 if it continues to sell-off. GBP is turning negative all over, but the spike has been unwound in many crosses.
Upcoming Economic Calendar Highlights
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
