FX Update: GBP resurgent, TRY hits new low on failure to hike rates.

Forex 5 minutes to read

John Hardy

Head of FX Strategy

Summary:  The US dollar has refused to stay down after its latest sell-of yesterday, while broad JPY strength remains. The key focus since late yesterday, outside of the sudden jolt higher in the JPY, is the huge bounce-back in sterling as the EU and UK resumed talks in London today. We wonder if ceiling is somewhat low for GBP even under the best of Brexit scenarios. Also pondering how to trade US election scenarios in JPY crosses.


Trading focus:

Pump and dump for sterling once again.
The pound sterling reversed back to the strong side as the UK and the EU sit down in London today to resume talks, ending the stand-off that developed late last week. Sterling is likely to head stronger still if the two sides can reach a sufficient level of agreement to “enter the tunnel” of final negotiation details – a signal that a “No Deal” scenario is off the table. This type of announcement could come anytime between now and mid-November and see an additional jolt of GBP strength. The focus in EURGBP is on 0.9000 and in GBPUSD on perhaps holding 1.3050-1.3100. If the USD continues weaker here while GBP rallies, the focus will quickly shift to the massive 1.3500 char level now that local resistance above 1.3000 has been broken. In the background, however, I wonder if the dire impact of Covid-19 on the UK’s economy, and not least its public finances, will mean that sterling could find a rather low ceiling in the near to medium term even under the most friendly of Brexit deal outcomes.

CNY appreciation halts suddenly
In yesterday’s update, I outlined some of the drivers of the recent CNY strength, while wondering if pronounced broad strength would continue much further, given that the official CNY basket is trading near the top of its multi-year range. Cue the largest weakening movement in the CNY versus the US dollar overnight in eight days – a decent sign that China may not be willing to tolerate the degree of broad strength it has seen in recent months, and that any further weakness in USDCNY(and the USD vs. offshore CNH, USDCNH), for example, will require more isolated USD weakness to do the heavy lifting.

Turkey skips a hike – TRY drops
The Turkish lira was sent over the edge again to new lows versus the euro and USD on the Turkish central bank’s decision to not hikes rates today. Polled analysts had a wide range of opinions on today’s move, with most looking for a hike, and one of about 175 bps. The Turkish lira naturally took the news poorly. Elsewhere, EM has been in fine shape lately, underlining Turkey’s specific woes and this decision could cost TRY holders another round of pain until the “right” message is sent to stem further weakness (or the EM mood could shift to a more neutral or negative level, raising the bar for the TRY to slow its descent). The Turkish central bank touted a positive normalization trend in commercial and consumer loans and a moderation of pandemic-linked imports and a strong recovery in exports of goods, although it did admit a higher than desired inflation level.

Watching the JPY very closely after yesterday’s jolt higher
Yesterday’s huge jolt higher in the JPY was a significant development and one worth keeping a close eye on. One can argue that this was a tardy reaction to a general weak US dollar move of late – especially versus the Asian giant CNY – or perhaps that stops were triggered in USDJPY on the move below 105.00 (the approximate low on two occasions over the last few weeks). But there was no proximate trigger to the move and the chief point of curiosity from here is two-fold. First, the USD and JPY have moved in broad sympathy in the crosses (strong positive correlation in strength/weakness) for years now and yesterday’s move was out of synch with that correlation. The other reason for sitting up and taking note is that the move has taken us south of 105.00 for the seventh time since 2016 – and on all previous occasions the price action has not tarried below that level for more than a few sessions (in most cases less than that even).

If we continue lower, does this trigger unease and an end to the complacency and low volatility in USDJPY options as hedgers are suddenly caught out? Possible. USDJPY puts over the election are one way to trade for chaotic outcomes over the US election, for example, whether it is contested or – even if a delayed reaction, but for my risk budget, I would prefer something like AUDJPY puts as a way to express optionality in JPY – or even half EURJPY puts and half AUDJPY puts.

Chart: AUDJPY
AUDJPY is a classic risk barometer within G7 currencies and one to watch over the US election and the reaction if a) assumptions around a strong Democratic sweep scenario are revisited and rejected as bad for risk sentiment and even US rates on a weaker growth outlook or more dramatic for the short term b) a contested election scenario that sees a major challenge mounted to the results that keeps uncertainty elevated into year-end. Finally, a c) scenario would be a weak Biden victory that is some combination of “b”, together with rather quickly emerging clarity that the Senate is likely to remain in Republican control – any Biden presidency without control of the Senate will mean at least two more years of total gridlock on stimulus and policy outside of foreign policy, as Congress maintains the power of the purse. Note the importance of the 74.00 area in AUDJPY in the chart below.

Source: Saxo Group

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