Head of FX Strategy
Summary: After the recent blow-up in the UK gilt market and severe sterling volatility, at least in part attributable to the fledgling Truss government’s budget-busting new initiatives, the new Chancellor Jeremy Hunt looks will bid to stabilize gilts and sterling by rolling back much of the Trussonomics platform. Efforts so far have already stabilized the EURGBP rate, so it is tough to see what more the market can wring out of sterling here on the positive side.
FX Trading focus: UK government bid to stabilize sterling. USD this week.
Sterling has rallied in fits and starts today on hopes that a rapid U-turn on basically all of former Chancellor Kwarteng’s tax cuts and even some tinkering with the hastily announced and generous energy subsidies will further stabilize the UK bond market and the currency itself. It may work – but stability does not mean sterling will necessarily strengthen. The next important test for confidence in UK bonds and sterling will be over new Chancellor Jeremey Hunt’s speech later today. Ahead of the speech, the news has crossed the wires that energy subsidies will only extend until April of next year as Hunt said in a statement that the government is cutting spending by £32 billion.
Otherwise, it has been a hairy few sessions for risk sentiment since last Thursday’s bizarre surge in sentiment in the wake of the US CPI data release, possibly driven by enormous profit-taking on speculative bets and protective derivatives hedging in the wake of that release. The sudden return of the meltdown in sentiment on Friday, one not readily attributable to any specific development, suggests that markets are still in a very touchy state as earnings season is set to get into full swing this week and on the ongoing tightening message from the US Fed. The improvement in sentiment today despite Friday’s ugly close may have been driven by the further stabilization of sterling and UK gilts finding strong support after the BoE wound down its emergency QE operations on Friday.
The US data calendar this week is fairly light, but will likely show that the US housing-related activity is cratering apace into the recession taking shape in coming months. The October NAHB survey is up tomorrow and the September Housing Starts/Building Permits are up Wednesday. One of the measures for this housing cycle – housing prices – is moving more rapidly than even the lead in to the financial crisis, as July showed an outright fall in house prices for the first time for this cycle (-0.44%), according to the CaseShiller US 20-City Home Price Index. And this came just a few months after the peak pace of appreciation early this year (well over 2% per month in February and March). The breathtaking turnaround is down to soaring mortgage yields of course, with the standard US 30-year fixed mortgage rising from around 3.25% at the start of this year to an eye-watering 7.2% at present. It is a vastly different cycle from the housing bubble era – where risky lending was a larger driver than the 30-year mortgage rate – the latter bottomed out near 5.0% in 2003 and never rose above 6.50% leading into the crisis.
Chart: EURGBP
As the week gets underway, the market seems satisfied that the UK government has learned its lesson and will reverse a sufficient percentage of the new Truss government’s spending and tax cuts intentions to avert further catastrophe for the UK gilt market, where yields are rapidly retreating, and for sterling, which already stabilized last week versus the euro upon the exit of former Chancellor Kwarteng. Let’s see where sentiment takes sterling after the speech today from new Chancellor Jeremy Hunt (at 1430 GMT). There is still a bit of support left for the pair in the 0.08625-0.8575 if the pair is to fully reclaims its former rangebound status. Without a more significant reversal in sentiment and the growth outlook for the UK and Europe on lower energy prices, I fail to see much further upside for sterling, with a best case that sterling merely manages to stabilize in the crosses and versus the euro here.
Table: FX Board of G10 and CNH trend evolution and strength.
The weak JPY remains a strong focus, as does the weak CNH as long as USDCNH is bidding up to new cycle highs above 7.20. The Bank of Japan’s Kuroda remains committed to easing, saying overnight that the BoJ will remain on an easing path and that inflation will push higher into year-end but come in below 2% next year and beyond. Elsewhere, the Aussie is a weakling among the smaller G-10 currencies on the dovish RBA and whenever risk sentiment is on the defensive, with a test for the NZD up tonight in the form of the Q3 CPI data.
Table: FX Board Trend Scoreboard for individual pairs.
It’s worth remembering that the FX volatility is very high these days – note that every single G10 pair listed below is in the “hot orange” category, which means the most volatile 10% of the range of the last 1,000 trading days. Note the nearly ubiquitous sterling strength, much of which is due to the strength of the bounce from very low levels – this will settle quickly if sterling merely stays flat. GBPUSD is trying to flip to a positive trend, with 1.1500 an important next area on the GBPUSD chart.
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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.
