FX Update: Sterling drops post-BoE. US real yields in focus.

Forex 5 minutes to read
John Hardy

Head of FX Strategy

Summary:  The market was pricing a fairly hawkish Bank of England meeting today and largely got what it expected, although the knee-jerk selling of sterling in the wake of the BoE statement suggests that more was needed to justify the recent buildup of more hawkish expectations around the meeting. Elsewhere, the slow fuse issue of Scottish independence may be lit in the wake of the Scottish Parliament elections today. Elsewhere, the USD is mixed as real US yield declined sharply.


FX Trading focus: Market knee-jerk a bit unfair on BoE meeting. US real yields weigh against USD.

The reaction to the Bank of England was an initial knee-jerk lower in sterling, if one that was partially corralled as of this writing. Many were leaning for a tapering of purchases to draw out the timeline of completing the overall QE package (i.e., leaving total size unchanged) and got what it wanted, as purchases will be reduced by GBP 1 billion per week during the May to August, when the next assessment will be made on the pace of purchases. The GDP growth rate for the year was raised to an impressive 7.25%, more than many were expecting. UK short rates and sterling may have declined slightly in the wake of the statement despite these development due to the wording and observations on inflation, as the Bank echoed the Fed’s language on inflation likely proving transitory over time, suggesting little urgency to hike rates:

 “Inflation is projected to rise to close to the target in the near term as some of those effects fade.  In the central projection, CPI inflation rises temporarily above the 2% target towards the end of 2021, owing mainly to developments in energy prices. These transitory developments should have few direct implications for inflation over the medium term, however. In the central projection, conditioned on the market path for interest rates, inflation returns to around 2% in the medium term”

But the guidance on the eventual removal of accommodation allows plenty of flexibility from the Bank down the line: “The Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably”. There was one hawkish dissent, but it was from outgoing Chief Economist Haldane, who leaves in June. The Governor Bailey press conference saw sterling somewhat weaker still as he stated that the bank’s tapering of purchases was not a taper (even though it de facto was!) and said that the Bank  has no new thoughts on the unwinding of QE.

Let’s see where sterling is tomorrow after today’s Scottish parliamentary elections as an absolute majority for the SNP is expected in the wake of these, meaning the inevitable campaign for a new Scottish independence referendum. It’s a slow fuse / slow burn issue, but one that can’t be ignored.

USD mixed to lower on commodity focus / plunging US real yields
The US dollar was on the move lower today as risk sentiment remained fairly stable and after an ugly swoosh lower in US real yields, as breakevens are soaring, while US treasuries have been solidly bid after mildly disappointing data yesterday. The April ADP private payrolls change disappointed about 100k (at 742k) and the April ISM Services index declined slightly to 62.7 after the record high of 63.7 in March, although I’m not sure we can extract meaning from such high levels in diffusion indices, although many will be tempted to see the March data cycle as having shown the peak in data, in terms of the pace of improvement. The  more positive data today (claims noted below) provided some offset to this development.

Regarding US real yields from here, it must be said that we should all be very alarmed if US nominal longer-term yields remain low while inflation expectations and realized inflation pick up further. This would suggest the market is pricing in real GDP declines, i.e., an outright falling standard of living and absolute drop in economic output. 

Norges bank on track for hike later this year. That was confirmed at today’s meeting, but NOK backed off, likely sensitive to recent downdraft in risk sentiment and a reversal in crude oil today, but the chart suggests the risk that NOK longs are a crowded trade.

The Aussie has absorbed the news quite well that China is breaking off all talks via its strategic economic dialogue “indefinitely”. Metals prices overnight on the re-opening of markets after the long holiday in China this week are a counter-support.

US weekly initial jobless claims dropped below 500k for first time post-Covid breakout with today’s reading of 498k. Tomorrow’s US jobs report is the macro finale to this week’s cavalcade of US data.

EURCHF in no-man’s land – having broken below the key range low south of 1.1000, although not back in the old range until the “gap” to 1.0900 is crossed. Not sure I understand what is driving this as long as economic optimism is on the rise in the EU.

Chart: EURUSD
EURUSD is rallying more determinedly above 1.2000 today, trying to get some separation and finding a tailwind in the dump in US real yields, although wobbly risk sentiment has kept the USD from suffering a consistent rout over the last couple of sessions. A full return back above 1.2100 to close the week after the US jobs data tomorrow might suggest that the consolidation is finished and the pair is ready to mount an attack on the highs of the year near 1.2349 , while extraordinarily strong US jobs data that sparks a rise in US treasury yields and forward Fed expectations (June FOMC sees new dot plot, etc., might require a word or two on tapering, etc..) could keep the EURUSD in consolidation mode for now. 1.1875 is the first real pain point significantly below 1.2000-1.1950.

Source: Saxo Group

Table: FX Board of G-10+CNH trend evolution and strength
CAD looking overdone here, given retreat in crude oil prices - and what if Canadian jobs data tomorrow disappoint? CHF looks at odds with JPY today – let’s see if that is sustained into next week.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs
Here, perhaps the most interesting signal is EURGBP trying to cross-over to positive after the BoE – awaiting follow through in the wake of the Scottish Parliamentary election results tonight. Also – note that EURNOK is on the verge of a cross-over to positive if it closes higher again tomorrow. Watching.

Source: Bloomberg and Saxo Group

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