A tumble too far for GBP?
- Geopolitics driving markets on light data week
- Has GBP reached its nadir versus the euro?
- Fed likely to post 25 bps rate hike in December
By Neil Staines
The data calendar so far this week has been sparse and with the assistance of a US bond market closure for the Columbus Day holiday yesterday, activity across financial markets has so far been relatively light.
With little data, what market ebbs and flows there have been have been driven by geopolitics.
EURGBP, for example...:
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“They all laughed at Christopher Columbus…” — Frank Sinatra
The Organisation for Economic Co-operation and Development declared yesterday that the UK will grow at a stable but slower pace for the foreseeable future as a result of uncertainty over its future relationship with the European Union. This is of course a far cry from the “sharp, sudden and dramatic slowdown in the UK economy” that the organisation had forecast before the vote in June.
The current government stance has given the impression of a bias towards a so-called ‘hard Brexit’, one which would likely cede access to the "single market" and revert to trading under WTO rules in order to impose restrictions on immigration.
The prospect of this has been a significant driver of GBP selling over recent sessions.
A leaked government report warning cabinet ministers that the Treasury could lose up to £66 billion/year in tax revenues under a hard Brexit has only exacerbated the move this morning. Some commentators have referred to this report as an extension of "Project Fear" or the last stand of the Remainers.
In the long run, however, we are of the view that the UK economy will be stronger, more flexible and progressive outside the regulatory confines (and lack of direction) that defines the EU.
However, in the near term, uncertainty is causing some to propose that the UK is going to sail off the edge of the world.
“We are calling more loudly for growth boosting actions” — Christine Lagarde
In the Eurozone, the bounceback in manufacturing activity and industrial production in Germany and Italy has done little to aid the euro, which is trading at its lowest level in over two months. Some Eurozone officials appear from their comments to be more interested in almost tantrum-like threats to the UK over the ongoing Brexit negotiations.
Luxembourg's prime minister commented over the weekend that “closing EU borders for a day would teach the UK a lesson”. We would argue that the Eurozone should focus less on teaching the UK a lesson, and far more on learning from the lessons of previous mistakes.
Meanwhile, European Central Bank chief Mario Draghi continues to urge national governments to “do reforms” while the “very substantial monetary support” is in place.
As far as the UK is concerned, we have some sympathy for the heightened sensitivity of GBP to the uncertainties surrounding the future trade and market access negotiations. However, GBP has fallen more than 35% against the EUR in a little over a year. During that period, the UK has outperformed in terms of growth and inflation metrics, and going forward we fail to see how a Brexit – irrespective of how "hard" it may be – could be singularly negative for just one side of the trading argument. Particularly as the UK is the predominant buyer in the relationship.
In short, as negative GBP sentiment appears to have reached fever pitch, we now suggest that there is increasing value in owning GBP versus EUR.
“Said I was reaching for the moon” — Frank Sinatra
Amid the dearth of economic data, markets will maintain an intense focus on the US for signs of a resumption of monetary normalisation in December (or even, though much less likely, November).
In this regard, it is interesting to note the comments of Chicago Fed president Charles Evans (widely regarded as being at the dovish end of the Fed spectrum) overnight, who suggested that Fed policy may be changing soon and that “one Fed move is not that big of a deal either way”.
His sentiment was, however, tempered in the longer-term as he maintained that the risks to inflation were to the downside and that the Fed should peg rate hikes to inflation progress.
It seems increasingly likely from our perspective that the Fed funds target rate will be raised a further 25 basis points in December, however, the Fed will likely continue to play down the pace of subsequent rises against the modest growth and inflation backdrop.
As 10-year US yields plumb their highest levels since June this morning, the emphasis of the Fed debate in September (the minutes of which will be released on Wednesday evening) will likely be key to any extension of this move – and thus potentially that of the USD.
— Edited by Michael McKenna
John J Hardy is head of FX strategy at Saxo Bank