Head of FX Strategy
Summary: With perfect hindsight, much of the recent aggravation of the USD spike was down to a troubled sterling as UK gilts markets were roiled by pension fund hedging after signals from the Truss government that fiscal prudence is a forgotten priority. With bond markets becalmed and sterling having come full circle from its level before the volatility event, we have now developed an additional narrative of a possible general central bank pivot to less tightening, driven by a couple of soft US data points and a dovish RBA. But can we get much more out of the pivot narrative here?
FX Trading focus: We have neutralized the GBP wipeout and a central bank pivot narrative has partially broken out. Now what?
Not much to add in today’s observations as yesterday saw an aggressive extension of trades aligning along the risk sentiment axis, particularly the US dollar lower, if mostly only against the European currencies. The lack of more pronounced breadth in the weakening greenback may be down to long US yields stabilizing ahead of the key 3.50% area in 10-year US treasury yield, but also down to the fact that the UK was at the center of the recent aggravated ramp up in the USD as treasury yields spiked. As well, positive news for Ukraine and softer natural gas prices in Europe are likely additional drivers for improved European FX sentiment. With GBPUSD trading back almost as high as 1.1500 this morning, the approximate kick-off area from where the UK gilt market melted down and took sterling with it starting after the September 22 Bank of England meeting, we now have to ask ourselves if there is more sustenance for a continuation of the move. Barring actual signals of a pivot from the Fed and/or energy and power prices in Europe dropping significantly further due to an actual visibility emerging on the longer term shape of Russian supplies, the answer is most likely “no”.
Of course, a big miss in the September US ISM Services survey today (expected at 56.0 vs. 56.9 in August) and/or a bad miss on payrolls and earnings in the Friday US September jobs report could drive an extension of the “central bank pivot” narrative in the near term, with the US dollar on its back foot. But weaker global growth is no boon to risk sentiment at some point beyond the immediate relief from a cessation in the seemingly inexorable rise in yields.
Chart: EURUSD
Parity in EURUSD an obvious psychological resistance line and was also the big, sticky round level that the exchange rate hugged for several weeks before the excursion to below 0.9600 that was mostly about the contagion (into a strong USD) from the sterling meltdown that was a traumatic liquidity event in the wake of the Bank of England meeting and the subsequent, deficits-be-damned moves by UK Chancellor Kwarteng. We are more or less back to square one, with the added narrative twist of a central bank pivot as noted above. Uniformly weak US data through Friday could drive an extension higher, but even a move to 1.0200+ may simply represent a larger scale consolidation within the massive downtrend, even if the downward channel denoted on the chart would be disrupted. A strong batch of US data and significant pull back higher in US yields would likely cap the action for now, although it will take some considerable work to get the downtrend back on track after this sharp back-up.
The RBNZ hiked rates overnight by 50 basis points, as expected, and it was the fifth consecutive hike of that size from the Bank. Given the less dovish guidance from the RBNZ in its statement relative to the RBA’s more modest hike and guidance, the AUDNZD dropped quickly to sub-1.1250 levels overnight before rebounding considerably – an underwhelming performance. That 1.1250 area, with a bit of slippage, is arguably the bull-bear line for that pair, with commodity prices, particularly energy, a possible determinant of whether the pair reprices back higher toward 1.2000 as I have argued might be possible due to the relative change in fortunes for the two countries’ current accounts over the last couple of years. A more significant assessment of policy awaits at the final RBNZ meeting of the year on November 23 (expectations still solid for a 50 bps move then).
EURCHF reached important resistance around 0.9800 after the thaw in risk sentiment and rumors of a troubled major Swiss bank helped Swiss government bond yields to drop far further than EU counterparts. Swiss yields have rebounded a bit this morning – hard to believe in a major reversal here unless we see a major further improvement in the European economic outlook.
Table: FX Board of G10 and CNH trend evolution and strength.
The USD uptrend is limping, if not yet reversed meaningfully in a broad sense. Note the weak commodity dollars -interesting to see if OPEC+ can pull off the threatened production cuts after its meeting today. Sterling has seen a mind-bending reversal over the last many days – maybe peak amplitude on that account for a while?
Table: FX Board Trend Scoreboard for individual pairs.
AUDNZD up-trend status in play here after the RBNZ reaction in favour of the kiwi has not stuck well. Note EURUSD trying to turn to a positive trend reading today – the ISM Services and ADP payrolls data the likely deciders there.
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
