Head of FX Strategy
Summary: The watershed moment of a major central bank, the Bank of England, forced to backtrack on tightening policy, even if only in “emergency” fashion, shoved global rates sharply lower yesterday. A chunky portion of that move was unwound today, but lower US treasury yields have taken the USD quite a bit lower after the dire drumbeat of rising yields in prior days. While in the longer term, the Bank of England’s move may presage a pivot from other central banks, but for now, it is far too early to call a Fed pivot.
FX Trading focus: The Bank of England is not the Fed
The Bank of England emergency QE news broke yesterday just before pixel time for my FX Update. I noted in the heat of the moment that it was stunning to see the fleeting rally in sterling before the currency then sold off, trading in GBPUSD terms below 1.0600 as, all things being equal, in a world of tightening central banks, an easing central bank is negative for its currency. Alas, later in the session sterling rallied sharply to new intraday highs, with GBPUSD trading above 1.0900 and isn’t particularly weak today. As discussed in the EURUSD chart below, that is likely down to US treasuries finding some sympathetic support and US treasury yields also correcting sharply yesterday – so, take down US treasury yields and the USD will have a hard time now following.
In the short term, if yields recover after this bout of volatility, and remain elevated elsewhere and we continue to see no sense that other central banks are turning away from their current tightening regime, and if the Truss government and its current tax cut policy stays in place (PM Truss has already been out defending the policy this morning) with no prospect of elections, sterling is likely to continue to face considerable headwinds. So, yes: the Bank of England may prove the canary in the coalmine in its policy pivot, even if a temporary one, and other central banks will inevitably eventually follow suit once yields apply sufficiently vicious pressure on their respective financial systems and/or economies (likely in that order), but what is the timeline? That is the overarching question. The Fed, for example, likely won’t ever really be able to get up to speed with its QT programme and has yet to show signs of doing so, but are we really already at the tipping point here and now because the BoE had to prevent market dysfunction linked to a sudden and wildly irresponsible policy overreach, together specifically with a panic pension fund hedging that risked a systemic meltdown? Possibly if the timeframe is the next few days or a couple of weeks, but our assumption is that we are some ways from a Fed pivot, even if markets could price it before the fact.
Chart: EURUSD
The BoE emergency QE reversed UK yields so sharply that global yields followed suit, as the US 10-year corrected over 30 basis points at one point yesterday as risk sentiment brightened. As the spike in US treasury yields was a key coincident indicator with the stronger US dollar, the back-off in yields helped ease the pressure on the USD. Since yesterday, risk sentiment has slipped a bit, and yields have rebounded a solid chunk of the move lower, but EURUSD has held onto yesterday’s gains quite well today, with some hawkish rhetoric from a variety of ECB members today (Kazaks specifically brought up the currency) adding a bit of extra support for the euro specifically. But a real reversal would need to see the pair solidly back above the 0.9900-0.9950 zone that defined the bottom of the range from July through earlier this month. Interesting to note that ECB hike expectations are slightly higher for the November ECB meeting (71 bps) than for the FOMC meeting (68 bps). At the same time, natural gas prices are on the rise again in Europe and geopolitical unease has ratcheted higher with this week’s bombings of the Nord Stream 1 and 2 pipelines. Just before pixel time, Germany has agreed to cap gas prices, which will need at least €150 Billion in funding, apparently with the pandemic funding going to this purpose. So much for long term investments…. This is not euro positive.
Note that CEE currencies are under significant pressure since the news of the pipeline explosions yesterday – this seems to be the most direction expression of the new “geopolitical unease” I note above on this development. EURHUF is pushing on 420 for the first time ever, EURPLN has spiked to new highs since the timeframe just after the breakout of war in Ukraine. Hungary continues to not support new sanction efforts against Russian energy imports. In Prague, protests have broken out against the country’s energy policy.
Elsewhere, Chinese officialdom has been out warning against “one way” speculative bets against the yuan, helping USDCNH sharply back lower below 7.15 after the exchange rate shot above the prior all-time (in the era of the CNH, not the CNY) 7.20 on Tuesday. China reports its official PMI survey data tonight ahead of a week off that will make trading conditions difficult for CNH traders as the onshore CNY won’t trade.
EM traders should note Brazil’s upcoming election this Sunday, October 2, as former left-leaning president Lula is strongly ahead in the polls, but with fears of election-linked violence and even an outgoing Bolsonaro who doesn’t want to leave quietly, or even at all. EM credit spreads have generally widened since mid-month with the last leg up in global bond yields. Corporate credit yields are likewise widening and closing in on the cycle peak from early July.
Table: FX Board of G10 and CNH trend evolution and strength.
The sharp drop in US treasury yields putting a dent in the USD upside, but it would take some doing to reverse the strong trend. Elsewhere, JPY surprisingly weak given they gyrations in yields since yesterday.
Table: FX Board Trend Scoreboard for individual pairs.
The CNHJPY downside attempt didn’t pan out at all, as the pair has ripped back higher, in part on official verbal intervention. May have to press pause on any CNH volatility until after next week’s full holiday. Note GBPUSD trading 78 days in a downtrend – around 1.0635 as of this writing after crossing into negative around 1.2000.
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