Head of FX Strategy
Summary: The Bank of England executed one of the more stunning communication fails in recent memory at its meeting, with its caution tripping up a market that was expecting a more hawkish meeting and sending sterling into a tailspin. Elsewhere, the Czech central bank hiked 125 basis points, more than the market was expecting. Today, the focus shifts to the US payrolls and earnings data, where the latter may show increasing sway on Fed expectations in coming months.
FX Trading focus: BoE trips up market, High bar for US jobs report? CZK carry trade?
Bank of England trips up market with no hike and forward guidance. A majority were looking for a 15-basis point hike at yesterday’s Bank of England meeting and fairly strong guidance from the bank on its intent to hike rates further at coming meetings. Instead, it got no hike and a Governor Bailey reluctant to commit to much in the way of forward guidance. The Governor had the gumption to say it was not the Bank’s job to guide the market “day by day and week by week” on interest rate hikes. He also waxed cautious on how the jobs market would behave in the wake of the recent end to the furlough scheme. The market was rather traumatized by this terrible communication breakdown after often urgent, if also confusing, rhetoric from Governor Bailey himself on the need to get started on hiking rates. Expectations for the policy rate by the end of next year dropped more than a full 25 basis points in the wake of this debacle as the market resets its expectations. UK jobs and earnings data will carry added weight from here relative to headline inflation.
There is a high bar for the US jobs report to jolt Fed rate hike expectations back higher, which is not to say that this and future reports don’t eventually clear that bar. Fed Chair Powell has set up a tense period for how to treat incoming data as he still believes that inflation will fall back even if “baseline expectation is supply bottle necks and shortages will persist well into next year and elevated inflation as well.” This suggests that almost any level of inflation in the coming handful or more of months won’t jolt Fed guidance without other incoming data clearly pointing to a rapidly tightening job market and even a budding wage-price spiral. Earnings could seize increasing attentionin particular, as huge payrolls growth numbers are unlikely to be sustained in a US labor market that is supply constrained by millions of early retirements during the pandemic, ongoing virus concerns keeping some parents in part-time roles, and vaccine mandates sidelining others. Today’s October Average Hourly Earnings rise is expected at +0.4% MoM and +4.9% YoY. The October nonfarm payrolls change is expected at +450k after the low +194k print for September. If the data is fairly in-line, not much may change at the short end of the US yield curve, but very interesting to see what happens at the longer end of the yield curve on any data surprise. Would hot data unmoor the longer end on the assumption the Fed is getting to reckless here?
Chart: EURUSD vs. 2-year EU-US yield spread
There is no iron law that says a currency pair has to track the developments in relative yields, but it is often an important driver, and the last year or so of market auction has shown a strong directional correlation. Will today’s US jobs report release keep US short yields relatively elevated after the ECB has pushed back against market pricing of rate hikes next year and send the EURUSD plunging through 1.1500, toward the ultimate trend test into the 1.1300 area (the 61.8% retracement of the rally from the 2020 lows to 2021 highs comes in at 1.1290.
Czech central bank hikes by 125 basis points, more than expected. The market was looking for a smaller, if still large 75- or possibly 100-bps hike to the policy rate in Czechia yesterday, but the central bank delivered more, taking the policy rate to 2.75%, the highest since 2008 as the bank attempts to get ahead of inflation risks after the Czech CPI reached 4.9% in September. Governor Rusnok said that inflation could reach as high as 7% this winter and promised more rate hikes to come. The next Czech CPI release is next week. EURCZK traded sharply lower yesterday in a further retreat from October highs above 25.75 and is now close to the range lows this year of 25.25, with CZK longs now earning over 300 basis points of carry versus the negative yielding Euro. Looking at the chart for the last few years since the Czech central bank raised the EURCZK floor back in 2013, there may be a significant psychological barrier in place into the 25.00-25.25 area, but shorting EURCZK offers more than 300 basis points of carry and the Czech central bank is delivering a hawkish message, hiking now and a lot, while the ECB is trying to guide that it is unlikely to see conditions in place for a hike next year. The 1-year forward EURCZK is almost a figure higher as more rate hikes are priced in – an interesting carry proposition.
Table: FX Board of G10 and CNH trend evolution and strength
The USD is tilting hard to the upside ahead of today’s jobs report. Does it achieve broad breakthrough? Elsewhere, sterling is tumbling into the abyss suddenly while Aussie and NOK have lost severe momentum this week.
Table: FX Board Trend Scoreboard for individual pairs
In the individual pairs, AUDUSD is tilting lower, USDCAD is tilting higher and NZDUSD is also on the verge of a flip to the downside in favour of the US dollar – all contingent on today’s US jobs report. JPY crosses in many places show directional sympathy with the US dollar direction – watching US yields for whether this might change (i.e., if long yields pick up again, as JPY often negatively correlated with US 10- and longer treasury yields.)
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
