- FX market caught off guard by Bank of England hawkishness
- GBP rally has plenty of room to run
- Expectations for a November BoE rate hike have jumped above 50% from 20%
- Solid August US CPI failed to inspire much USD strength
- Market shrugged off N.Korean missile launch after knee-jerk dip in JPY crosses
Sterling's rally has room to run. Photo: Shutterstock
By John J Hardy
The market – and us, too – was caught sorely off guard by a significant hawkish upgrade to the Bank of England’s language on Thursday, including a few phrases saying that the bank will look to hike rates in “coming months” if the slack in the economy continues to be unwound.
Perhaps it was the high 2.9% August core inflation that spooked the bank, despite the August declaration that it was willing to ignore higher inflation. Or perhaps the BoE feels the need for more flexibility after the government was forced to abandon the public sector wage cap, which could lead to significant advances in wage pressure on inflation in the quarters ahead.
Regardless, the market was caught the wrong way around, and the magnitude of speculative positioning could provide plenty of fuel for a further rally. Known BoE dove Gertjan Vlieghe is scheduled to speak today, but this may not hold back sterling and could even accelerate the rally if he changes his tune like governor Mark Carney (who late yesterday said he was among the majority in favour of a rate hike in coming months). The market’s expectations for a November rate hike have shifted from well below 20% to above 50% in about a week. That's a sea change.
Elsewhere, a reasonably supportive US CPI report yesterday failed to sustain a rally for the greenback, even as US short-dated yields have backed up in sympathy with rates elsewhere. The December rate hike odds have pulled back closer to 50/50 from recent lows, but the more significant upgrades to the policy hikes elsewhere have put the brakes on the USD’s upside potential. The expectation is that the Fed can talk quantitative tightening with an October 1 start date and $10 billion/month reduction of the balance sheet, and that the December guidance can be left open-ended, with incoming data shifting the odds and the Fed acting accordingly.
Another North Korean missile launch over Japan showed the capability of reaching the US military base in Guam. This was quickly shrugged off after the quick knee-jerk dip in JPY crosses overnight, and the yen may remain the weakest of G-10 currencies if yields keep rising, provided the Bank of Japan can continue to provide 100% reassurance of its purchase target and yield curve control. At some point soon, however, we are increasingly wary of adjustments in the BoJ guidance, as the Japanese government bond 10-year yield approaches the BoJ’s cap at around 10 basis points. Previous visits to this level have been fended off, but that was made easy by a fall in yields elsewhere. A real testing of the BoJ’s mettle with a more significant rise in long yields globally will be an interesting showdown to watch and might force the BoJ to shift its targets.
)is rapidly approaching the key 1.3500 area, which was the low during the global financial crisis and the high after the initial post-Brexit vote move. A further upgrade of the BoE rate path from here, and any sense of clarity on Brexit (doesn’t seem able to get worse) could see the pair blowing through this resistance and testing to 1.4000, effectively closing the "Brexit gap".
The G-10 rundown
USD – the USD rally fizzled, which was especially disappointing for bulls after the solid August CPI. A weak or even merely indifferent retail sales report could see the USD weakness picking up pace again.
EUR – the euro has fared rather well, given the pressure on EURGBP from the market’s reassessment of the BoE's rate outlook. EURJPY certainly looks poised to etch strong new highs, and disappointing US data could see EURUSD on the comeback trail above 1.2000, even as the ECB rate view has sorely lagged developments elsewhere.
JPY – the yen could remain the weakest of the lot, as indicated above, but there are significant risks of the BoJ adjusting its guidance, starting with next Thursday’s BoJ meeting, though that may be too early. EURJPY is testing new highs for the cycle this morning – impressive.
GBP – enough said above – there could be significant further upside potential, with the next test a general assessment of sentiment around next Thursday’s Brexit speech from prime minster Theresa May.
CHF – hawkish adjustment from the Swiss National Bank in its statement, but clearly this was only prompted by having a decent weakening of the CHF in the bag. So the bank is more reactive than proactive, and CHF may generally lag the market as long as yields are pulling higher and risk appetite is strong.
AUD – Australian rates are pulling to new highs for the cycle after wobbling a bit overnight on the North Korean missile launch. 0.8000 in AUDUSD continues to act as the bull/bear line.
CAD – a small shooting star reversal in USDCAD provides fresh encouragement for bears, but we’ll need to see the US data today for confirmation.
SEK – Swedish interest rate moves are at very low beta to the big moves elsewhere, which leaves market anticipating little volatility.
NOK – Norges Bank meets next week, and the rate outlook is entirely moribund despite all the noise elsewhere. Not sure what could change that, but the oil price is certainly doing its part to encourage NOK resilience.
Upcoming Economic Calendar Highlights (all times GMT)
- 0850 – Bank of Englands’ Vlieghe to speak
- 1230 – US Aug. Empire Manufacturing
- 1230 – US Aug. Retail Sales
- 1300 – Canada Aug. Existing Home Sales
- 1315 – US Aug. Industrial Production and Capacity Utilisation
- 1400 – US Sep. Preliminary University of Michigan Confidence
— Edited by John Acher