FX Trading focus: Market hoping for a goldilocks vibe.
The powerful reversal in energy prices after Russian president Vladimir Putin claimed yesterday that Russia is ready to supply the market with gas has dramatically improved sentiment in Europe and in generally risk-correlated FX, although you can’t see much of that improvement in the euro, where the dovish ECB holds back upside potential. Also supportive of risk sentiment is the US Senate apparently readying to punt the debt ceiling issue out to December, while treasury yields have remained orderly at the long end of the yield curve despite the general relief and the very strong Sep. US ADP private payrolls change yesterday, at +568k. That strong report may nudge expectations higher for the official Nonfarm payrolls change number tomorrow, which, together with the Average Hourly Earnings data is the next test for whether a kind of brief “Goldilocks” interlude can be achieved here in which yields remain tame at the long end of the curve and the energy crunch story fades for now, helping to relieve concerns of stagflationary outcomes.
I’m not a fan of the idea – but we just may have a window if the US jobs report is sufficiently boring. Surely a reasonably strong US jobs report surely sees a fresh pull higher in US yields? Let’s see, Powell spelled out at the press conference of the September FOMC meeting that the Fed doesn’t need a particularly strong report tomorrow to move forward with a QE taper, but if we get a very strong report, together with much higher than expected average hourly earnings, this could affect the pace of tapering and jolt this market.
The ECB is said to be studying how to continue doing QE beyond the telegraphed expiry date of March of next year to their PEPP program. Maybe it should consider funding some resilience in the EU’s energy supply system, although given Lagarde’s focus on the climate, linking the next round(s) of QE to the climate agenda wouldn’t be a huge surprise.
Sterling is on the brink of key resistance in GBPUSD as the 1.3600+ area the was so important on the way down has been in play in recent sessions. Prime Minister Boris Johnson’s speech yesterday seemed to make a solid impression on BoE rate expectations as he talked up the Conservative “Build Back Better” and “Leveling up” platform. Just over the last few weeks, UK 2-year rates have outpaced EU rates by more than 20 basis points as rate hike anticipation from the BoE rises. The UK-EU spread is around 118 basis points today and at its widest level in more than two years (the high in this spread since way back in 2007 is a mere 138 basis points – we’re almost there). Against the US, the UK 2-year spread is also widening – with the UK-US rate spread rising a further 15 basis points in under a month to reach the current level near 35 basis points. I doubt sterling is responding as much to these developments as it is to the relief on the energy crunch/risk sentiment side of the equation, which seems to dominate the correlation with GBPUSD more so than yield spreads, even if the latter certainly don’t hurt and get more focus if risk sentiment continues to improve. Regardless – the 1.3600-50 area in GBPUSD and the 0.8450-0.8500 zone look pivotal for whether sterling can achieve a new lift-off in coming days and week or whether it is brushed back lower on the fears that have seen it underperforming the rate rise developments this year – including Brexit uncertainties, lower real rates, and capacity constraints in energy and transport and supply chain infrastructure. The huge correction in energy prices is especially a relief for the import-reliant UK.