The dollar versus the dole
- Nonfarm payrolls release likely to see pronounced USD move
- Evolution of relative real and nominal yields point to downward bias in EUR
- 'Next stop for the US is stagflation': Alan Greenspan
By Neil Staines
Soon after the Asian trading session had started last night, GBP encountered a severe market dislocation. GBP gapped down more than 6% in minutes as a perfect storm of barrier stops, date change, illiquidity, and electronic algorithmic trades exacerbated a move that had no legitimate macroeconomic cause.
There will be much discussion emanating from this move about electronic trading, bank market making capabilities (and regulation), barrier execution, and the liquidity structure of FX markets, we have no doubt. For now at least, we will reserve judgment.
“There is no stability without solidarity and no solidarity without stability” — Jose Manuel Barroso
In the UK, the market implied (SONIA) probability of a November rate cut continues to decline, as the data point to domestic resilience and export outperformance. Recent sessions have also demonstrated that sterling has become more sensitive to the medium-term uncertainties surrounding Brexit negotiations than the current macroeconomic trajectory.
From our perspective, this is unlikely to last. Furthermore, it is unlikely from our viewpoint that the Brexit negotiations hold universally negative connotations for the UK, or are at least not without equally damaging connotations for the remaining European Union members.
If we add into the equation the expanding global shift towards fiscal policy and structural reform as the natural transition from increasingly impotent monetary stimulus, then the fact that Spain currently has no political leadership, that Italy could soon follow (should the referendum fail), and that general elections in both Germany and in France are coming next year, the political structure of Europe is far from stable.
To paraphrase European Commission president Jean-Claude Juncker, the European Union needs more union.
From a medium-term perspective (and last night’s market dislocation aside) we feel that the EU/UK economic, political and monetary differentials are all likely to err increasingly in favour of GBP from the current juncture, and we would expect EURGBP to become increasingly vulnerable.
“If you do not change direction you may end up where you are heading” — Lao Tzu
Earlier this week, the release from European Central Bank sources of discussions on the bank's exit strategy from its current QE expansion drove EUR and bond yields higher. In reality, the comments – the report stated that “ECB said to near consensus on need to taper QE before it ends”, and that the timing of such tapering was said to “depend on the economic outlook” –gave very little, if any, real information
The bounce, however, was both real and fairly substantial; in that regard, the minutes of the September ECB meeting were keenly awaited.
At the early-September press conference, which came against a backdrop of recovering equity markets (post-EU referendum declines) and declining volatility, the ECB appeared relatively ambivalent and gave more of a "fingers crossed thatwhat we are doing is enough"-type statement rather than one ready to contemplate tapering of any kind.
Indeed, the fact that growth estimates were revised lower (for both 2017 and '18) and that “underlying inflation was showing no signs of an upward trend” suggested that an exit strategy was not the bank's most pressing concern.
In valuation terms, we see the evolution of relative real and nominal yields as being suggestive of a downward bias in the EUR. Deteriorating political stability and a rapid expansion of the ECB’s balance sheet are compounding arguments, particularly if our expectations of weaker growth trajectories and a resumption of regional funding concerns reemerge over Q4 and beyond.
“The next step for the US recovery is stagflation” — Alan Greenspan
In the US, the debate over the momentum of the labour market was given mixed signals this week with a further suggestion of slowing momentum in the ADP survey, but an unexpected surge in the non-manufacturing ISM, a sector that accounts for almost 80% of the economy.
This surge, however, was not mirrored by the Markit services PMI reading for the equivalent period, which pointed to the smallest monthly gain in jobs growth since April 2010 combined with weak business optimism and heightened political uncertainty.
Bond yields and market-based Inflation expectations have risen more clearly over the past week. Two-year yields have made new cycle highs (above 85 basis point) following hawkish rhetoric from the likes of Richmond Federal Reserve president Jeffrey Lacker who said Wednesday that “there is a strong case to raise rates more rapidly”.
This afternoon’s employment report is likely to have a disproportionate impact on rate expectations, the USD and – after last night’s moves in FX – on volatility.
— Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group