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.
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.