FX Trading focus: Waiting out the complacency. Bank of England goes dire – UK yields shrug.
The Bank of England issued perhaps the most remarkably dire outlooks for an economy ever at its meeting yesterday, suggesting that inflation will peak at 13% later this year as the UK economy is set to dip into a prolonged recession starting in Q4 of this year and extending through the next calendar year. Yields traded all over the place in the wake of the expected 50 basis point hike, the largest in 27 years, as the market tried to draw implications on whether the BoE would continue moving in 50 basis point increments over the next couple of meetings, given the pessimistic outlook. In the end, the market decided that the incoming inflation forecast will keep the hurdle high for any BoE downshift and the market retained expectations for more large hikes to come, with 45 bps prices for September and another 41 bps for November. By the end of the day, Governor Bailey managed to convince that the bank is forced to forge ahead to get inflationary risks under control despite the gathering clouds and continued to note the risks of an inflationary spiral becoming “embedded” in the economy. The balance sheet reduction plan announced yesterday is at the more aggressive end of the £50-100 billion/year range at £80 billion. Sterling now has to trade on sentiment as opposed to rate spreads – any rapid deterioration in sentiment could see the pound looking vulnerable again versus USD and perhaps CHF, and even JPY if yields remain subdued.
The USD was mixed yesterday, staying firm against commodity currencies as the recent slide in crude oil prices suggests a market gearing up for recession risks. After an intraday rally, the USD was pushed back lower against the EUR and JPY as soft US weekly claims kept US yield tames and complacent risk sentiment continues to hold back the dollar. If the US jobs data solidifies the view that the US labor market is softening and pushes yields lower, the greenback may see an intensification of this pattern, with USDJPY particularly yield-sensitive and EURUSD possibly squeezing into a flurry of stops, likely above 1.0300. A far stronger than expected jobs report together with a considerable upside surprise in the average hourly earnings data in particular could see the USD broadly stronger. EURUSD needs to resolve one way or another soon after nearly three weeks in the 1.0100-1.0275+ range. Further out, the dire energy/power situation as Europe looks forward to the risk of a dark winter and power cuts, potentially to whole swathes of its economy, will likely keep a lid on an EUR upside ambitions beyond a positioning adjustment.