GBP suffers biggest daily drop in over a month
The pound faced a bout of selling pressure yesterday and it was likely a result of more profit taking, overstretched long-GBP positioning and rising concerns regarding the potential occurrence of a recession following the Bank of England’s (BoE)’s aggressive policy tightening in recent months.
As we highlighted on Tuesday, GBP/USD has indeed succumbed to test its 100-week moving average nearer $1.26. Hawkish comments from top central bankers have also tainted risk sentiment somewhat, causing equities to slide and weighing on the risk sensitive pound. Meanwhile, GBP/EUR has slumped to its lowest level this month, sub-€1.16, despite attractive yield spreads in favour of sterling. This is evidenced by the decoupling of UK-German two-year bond yields with GBP/EUR since the BoE’s jumbo hike last week. With money markets pricing that the main UK interest rate will peak above 6% by February 2024 though, this should, in theory, support sterling from falling too much further due to its yield appeal.
However, more aggressive rate hikes, hawkish talk and surging rate expectations also increase recession fears and doesn’t give much room for hawkish surprises from here. Hence, incoming data next month will be crucial and any signs of the labour market or inflation easing, could weigh on these rate expectations and drag GBP/USD towards $1.25 in the short-term and GBP/EUR towards €1.15.
Powell limits ECB’s influence over the Euro
The Central Bank Forum in Sintra gave the ECB a good opportunity to underline their commitment to continue raising interest rates. However, there seems to be a limit to how much hawkish ECB policymakers can force markets to reprice the yield curve higher and to reduce rate cutting bets in the face of faltering economic data. While yields on the short end have risen in the past 1, 3 and 6 months, yields on the long end have remained flat, moving around the same mean level since the beginning of 2023. This has led the German yield curve to invert the most since the 1990s, with around 80% of possible yield curves already negative.
This comes after macro data consistently came in weaker than expected over the last few weeks. The Ifo, GfK and ZEW surveys have now all been released for the month of June and have confirmed the pessimism that has started to build around Germany. Business, consumer and economic expectations stayed in negative territory with the weakness in the Ifo index dragging our soft data proxy for Germany down for a second consecutive month.
The improvement of the current conditions index, which started in October following the bottoming of leading indicators, has stalled as well. However, the close relationship between economic expectations and the euro has broken off in June, with EUR/USD rising on the back of positive risk sentiment and a hawkish ECB. It will be interesting to see if this divergence persists into July. The euro did not profit from the hawkish tone the ECB set this week as markets were more focused on Jerome Powell and the Fed. EUR/USD is trading nearer $1.09 again and is opening the day lower.
US economy just doesn’t slow down
The pandemic and consequently the fiscal stimulus measures have unleashed a consumption boom of durable goods in the United States that is still ongoing. While the share of spending on durable goods in relation to GDP has somewhat normalized from 20-year highs (9.7%) reached at the beginning of 2021, the trend of nominal goods spending still far exceeds the ones seen after previous crises. Pandemic related factors – labour shortage, excess demand – continue to shape the US economy and have positively influenced recent macro releases such as durable goods orders and labour market data.
This might be one reason for the unusually large disconnect between lagging and leading economic indicators at the moment. While forward looking indicators like the PMIs, the Conference Boards Economic Index and the yield curve point to high recession probabilities, most backwards looking indicators are doing just fine. This week’s surprisingly strong housing, consumer and durable goods data has seen the Citi surprise index for the US jump higher again, increasing the macro divergence with Europe.
Markets have added to their bets of another rate hike in July, which has increased the implied probability of a further tightening to above 80%. No rate cuts are expected until March next year. The dollar has profited from this hawkish repricing and is on track to rise for a second consecutive week. Today’s focus will lie on European inflation data. However, another appearance from Jerome Powell, the GDP release and pending home sales might add to the volatile environment.
GBP/USD down 1% in a week
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: June 26- June 30
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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.
