FX Update: Sterling found resistance. Geopolitics drive fresh unease.

FX Trading focus: Sterling went full circle, market sentiment risks deteriorating again despite bond market stabilization

Sterling traded to 1.1200 overnight before dipping sharply and then rising to back above 1.1200 briefly in the European morning session today on hopes that a meeting today between UK PM Truss and Chancellor Kwarteng and the Office of Budget Responsibility chief will result in the Truss government rolling back some of the recent measures that unsettled market confidence in UK gilts. The political pressure is certainly mounting after the latest YouGov poll showed Labour with a 33-point lead in the polls, the widest margin since the 1990’s. With 20/20 hindsight, it is easy to see that the gilt wipeout saw significant contagion into other bond markets and that the stabilization of yields has likewise been global in scope. Interestingly, despite yesterday’s very weak risk sentiment that erased the prior day’s “risk-on”, the US dollar remained weak, apparently as the focus is more on treasury yields? That USD weakness has in turn faded and I gave a hard time seeing renewed broad USD weakness as long as financial conditions (outside of sovereign bond markets, which so quickly become existential) continue to deteriorate: for example, with fresh lows for equities and as high yield credit spreads are now back near the cycle highs from early July in the US. Practically speaking, the big EURUSD pair would have to reverse back above 0.9900-0.9950 to revisit that view. In the early European afternoon, we are already trading a figure back below the 0.9850 highs of the last session.

Germany has declared a €200 billion package to save its consumers and industry from high natural gas and power prices, to be funded from pandemic funds. This is simply absorbing the current pain onto the sovereign balance sheet in order to keep significant portions of the economy from being wound down. It’s ironically a kind of demand support akin to what pandemic spending did, at a time when the currency needs for energy prices to fall for support. Especially as long as the Fed fails to ease, external deficits from subsidized energy plans will continue to wear on the euro and the pound. These measures will only prove wise in the long run if the high energy prices are transitory on a scale of a few months. If the situation fails to ease very significantly next spring and summer and we fail to see the prospect of a longer term return of low energy prices, these subsidies will be a disaster for the currency and for the public balance sheet.

Chart: GBPUSD
Sterling has come full circle since the vicious sell-off was initiated near 1.1200 late last week in GBPUSD in the wake of the tax cut announcements that seemed to serve as the final straw for sterling, as gilts were already under vicious pressure, in part from the lackadaisical pace of Bank of England tightening. Alas, the BoE rescue has helped stabilize not only the local bond market, but also global sovereign bond markets, which continued to find support even as risk sentiment generally reversed yesterday… suggesting if risk sentiment worsens, it may have more to do with financial conditions elsewhere as discussed above. Judging from today’s price action, the 1.1200-1.1250 area looks the tactical upside pivot zone and 1.1500 the last area of price stability higher and the larger kick-off point of the down-wave. Looking lower, the 1.0800 area is the next import zone of price congestion