Risk sentiment rebounds before key US inflation print

Labour data trumps fall in bank lending; sterling bounces as risk appetite returns and the euro firms as key data eyed.

George Vessey, UK FX & Macro Strategist

Labour data trumps fall in bank lending

With subdued liquidity at the start of the trading week due to holidays in major regions, markets have been digesting last week’s economic data. The US non-farm payrolls report in particular has supported the notion that the Federal Reserve (Fed) might continue hiking rates in May even against the backdrop of rapidly deteriorating bank lending volumes.

The US economy added 236 thousand jobs in March, beating expectations for an 11th consecutive month. The unemployment rate fell from 3.6% to 3.5% in line with expectations, while hourly earnings fell slightly to 4.2%. While other labour market indicators like initial jobless claims and job openings have started deteriorating in recent weeks, job growth has remained resilient. This has raised the probability of a Fed rate hikes to 80% again. Even though the two-week decline in bank lending in the US has been the largest on record, showing that tighter lending standards are leading to weaker lending activity. The real estate market remains the most vulnerable sector to follow as the impact of bank lending is most direct there.

EUR/USD failed to break through $1.10 last week and is now trading just under $1.09. The pair has seen a slight rise in today’s morning trading, appreciating by 20 basis points and is still up 12% in the last twelve months.

Deposits have fallen by $878bn in the last 12 months. US commercial bank deposits (seasonally adjusted).

Sterling bounces as risk appetite returns

The risk-sensitive pound is back above $1.24 against the US dollar after sliding to a low of $1.2343 yesterday following four modest daily declines in a row. The currency pair closed below its 10-day moving average for the first time since early March though and will need to close above $1.24 today to shake off any further downside pressure in the near-term. The main risk event is US inflation on Wednesday, but sterling traders will also keep an eye on UK GDP and industrial and manufacturing production on Thursday.

Last week, Chief Economist Huw Pill said that the Bank of England (BoE) still could not be sure that it has raised interest rates enough to tame inflation, which unexpectedly jumped to 10.4% in February, whilst food inflation rose to a record high in March. Money markets are currently pricing an 80% chance the BoE will hike by 25-basis points in May and the resilience of the UK economy continues to point to such a move as demand for services remains robust, and core services inflation remains sticky. This morning, data published showed retail sales in the UK rose 4.9% on a like-for-like basis in March 2023 from a year ago, above market expectations of a 4.2% gain. A continuation of above-forecast data that paints a picture of a resilient economy still able to generate above-target inflation levels, has clearly reignited concerns within the BoE. However, rising UK gilt yields as a result of rising UK interest rate expectations, are helping to support the pound.

As well as domestic developments bolstering sterling demand, the risk-correlated currency continues to swing with global investor sentiment. After yesterday’s rise in risk aversion weighed on the UK currency, the rebound in risk appetite this morning has seen equities rally across the board along with the highly correlated British pound, which is now less than 1% away from its 10-month high against the US dollar.

Resilient UK economic activity boots growth prospects. UK: GDP vs composite PMI.

Euro firms as key data eyed

The euro is on the front foot this morning after easing away from a 2-month high versus the US dollar last week, whilst GBP/EUR continues to grapple with the €1.14 level after three weekly losses in a row for the common currency. Rising expectations that the European Central Bank (ECB) will continue raising interest rates over the coming months to combat inflation remains a key euro-positive factor. Hard data from the Eurozone will be closely watched this week to get a sense of how GDP has developed over the first quarter, though data surprises have failed to drive the euro much so far this year.

Despite European bank lending to businesses contracting and money supply plummeting, the perception of reduced stress in the banking system by market participants has helped buoy global risk sentiment. European stock futures are advancing as positive momentum picks up following a late recovery in post-holiday trading on Wall Street, whilst EUR/USD is inching back towards $1.09 after six weekly gains in a row. For now, absent fresh bad news from the banking sector, investors will likely refocus on longer term influences such as economic data, which could determine whether EUR/USD tests $1.10. Today, Eurozone retail sales data for February is expected to have fallen, but a rise in industrial production is forecast (due later this week). Given the slew of better-than-expected data from Germany of late, our hard economic data proxy indicator shows the surprise rebound of the industrial sector is starting to make the first quarter recession call for Europe’s biggest economy less likely. However, a looming threat to any positive data boost for the euro is slower loan growth and tighter credit standards potentially acting to suppress goods and services demand.

Meanwhile, tumbling money supply is also gaining attention, pointing toward recession and a rapid decline in inflation. The annual broad money growth rate in the Eurozone is well below its 2010 average – associated with below-target inflation – which complicates the ECB’s monetary policy outlook. Reduced money supply, coupled with tighter lending conditions, could lead to disinflation and even deflation, meaning less scope for more ECB hikes, which would likely weigh on the common currency.

Data surprised have not driven the Euro this year. Economic data surprised for the Eurozone, US and EUR/USD.

Big GBP gains seen against riskier currencies

Table: 7-day currency trends and trading ranges

7 day currency trends and trading ranges.

Key global risk events (CEST time zone)

Calendar: Apr 10-14

Key global risk events calendar.

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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.

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