Macro/FX Watch: GBP could weaken further on Fed’s hawkish posturing

GBP: Knocked lower by dovish BOE remarks

GBPUSD pushed below the key 1.23 handle as BoE Chief Economist Huw Pill made a case for inflation slipping below 5% for the October print due next week and opening up the door for markets to price in more easing as he said that rate cuts from next summer looked reasonable. Recent polls have highlighted the steep cost-of-living crisis in the UK, with two-thirds of UK adults not looking to participate in Black Friday and Cyber Monday. This continues to deepen recession concerns for the UK economy, and threatens further downside for cable and other sterling crosses.

Speech from BOE Governor Bailey will be on watch today, but Fed Chair Powell could have a bigger focus. If he maintains a hawkish posturing, echoing what Kashkari said yesterday and keeps the door open for further tightening, then the Fed-BOE divergence will likely come into limelight. UK’s data docket is also full for Friday, with Q3 GDP particularly on watch. Consensus expects growth to slip into negative at -0.1% QoQ from 0.2% QoQ in Q2, which could signal the incoming technical recession. Market is currently only pricing in 50bps of rate cuts in the next one year, so dovish repricing risks could weigh on sterling in case data comes in weaker than expected.

Moreover, sterling has seen a significant correlation to US equities. The above table shows that GBPUSD has the highest positive correlation to S&P 500, more so than AUDUSD. If the Fedspeak weighs on equities, that could deal a double blow to sterling. GBPUSD could test 50% retracement level at 1.2232 ahead of 21DMA at 1.22 and EURGBP could head back higher towards 0.8750.

Market Takeaway: Sterling weakness could accelerate on weaker economic data given scope for dovish repricing by the markets. GBPUSD could test 1.22 and EURGBP could rise towards 0.8750.

NOK: Plunge in crude oil prices underpinning

NOK was the clear underperformer on Tuesday, as it was rocked by Brent crude oil completely unwinding the war premium. EURNOK rose higher to get in close sight of the 12 handle, and higher US yields could bring a test of the big figure again.

EURNOK rose above the 12 handle in May-end but could not sustain the move. Over the last 1 month, NOK has underperformed all other G10 currencies by a wide margin both against the USD and EUR. Norges Bank held the policy rate at 4.25% last week and has maintained a data-dependent approach for December. Market is pricing close to 40% chance of a 25bps rate hike in December. If inflation (due to be reported on Friday) remains on a decline, that will increase the odds of interest rates staying on hold, further weighing on the krone. On the other hand, Sweden’s inflation due next week could still continue to show an uptick due to base effects, which keeps the case for a final rate hike from the Riksbank alive for November.

Market Takeaway: Both NOK and SEK are likely to trend weaker but expectations of a final rate hike from Riksbank could bring downside in NOKSEK.