Written by Convera’s Market Insights team
Euro vulnerable to geopolitical escalation
Ruta Prieskienyte – FX Strategist
Unwinding safe-haven flows provided some respite for the euro from a steep two-day selloff against the US dollar at the end of last week. The euro recovered against its major peers yesterday as investors await German ZEW surveys, Q3 corporate earnings and continue monitoring the developments in the Middle East. EUR/USD is back on the defensive already this morning though and remains about -3% below its 2023 average.
The Hamas-Israel conflict escalated further on Monday as the Israeli air strikes on Gaza intensified after diplomatic efforts to arrange ceasefire in the southern Gaza failed. President Joe Biden plans to visit Israel on Wednesday after a US-led effort to allow aid into the Gaza Strip faltered. Signs are emerging of mounting risks of a broader Middle Eastern war. On the norther border, Lebanon’s Hezbollah and Israel exchanged in the deadliest escalation since a major war in 2006 and Iran insinuated at regional aggravation if attacks on Palestinians continue. Despite that, Brent oil edged lower on the back of a 6% rally in the oil futures seen on Friday but continues to trade close to a 2-week high. An expanding conflict is likely to put upward strain on oil prices and exacerbate inflationary pressures and, as a by-product, interest rates around the world might need to rise further. IMF estimates that a 10% rise in oil prices could shave 0.15% off GDP growth next year and add 0.4% to global inflation.
We’re watching the impact on oil prices closely, because if the price of a barrel tops $100, this is likely to drag on currencies of regions that are net importers of energy, like the euro. A continued resurgence in energy prices could be the main catalyst to send EUR/USD closer to parity in the short term, but a euro recovery in 2024 remains our base case scenario for now.
Easing UK wage growth weighs on pound
George Vessey – Lead FX Strategist
There has been a delay to the release of some key UK labour market data, raising concerns over the accuracy of figures that are closely watched to inform Bank of England (BoE) interest rate decisions. However, wage data was published and came in below expectations, weakening the pound across the board.
Regular pay, which excludes bonus payment in the UK, rose by 7.8% y/y in the three months to August, below an upwardly revised 7.9% rise in the previous period. Wages in the private sector rose 8%, below 8.1% in the previous period and 6.8% in the public sector, compared to 6.6% in the previous period. The dip in wage growth, ahead of key inflation data tomorrow, should make it easier for BoE policymakers to keep interest rates at 5.25% after a series of 14 consecutive hikes since the end of 2021. Markets are exceptionally data-dependent, reacting sharply to economic or inflation numbers that do not come in line with expectations, hence the pound’s negative reaction to the sign of a cooling labour market. The pound has weakened mostly due to markets paring back expectations of Bank of England’s rate hikes. Although market pricing still indicates about a 50% chance of one further 25 basis point rate hike this cycle, which would take Bank rate to 5.5%, that’s a lot lower than the 6.5% peak priced in in July.
The pound is up against 85% of 50 global currencies we’ve been tracking since the start of the year, but the pendulum has swung against the British currency recently, with it only stronger than 25% of those same currencies over the past three months.
Retail sales expected to show evidence of weakness
George Vessey – Lead FX Strategist
Strong consumer spending and a resilient labour market have pushed out recession calls for the US and have put the possibility of a soft landing back on the table in recent months. The rise in long-dated government bonds yields has been a result of this better growth outlook, but today’s US retail sales and industrial production data could muddy the outlook.
Government bond yields on the long end and the estimated GDP growth rate of the US had both peaked in October last year and had mostly moved sideways for the next 10 months. However, since July, they have continued their ascent in parallel. Do we need to see significantly lower US growth rates for 30-year yields to fall back below 4.0 – 4.5%? With short-term interest rates at 20-year highs starting to work their way through the economy, some loss of economic momentum is to be expected. High-frequency credit card spending numbers in the US have been soft in September, so we could see a weaker retail sales report. Moreover, auto-related strike action of late increases the risk of a downside surprise in industrial production. The market pricing of a final rate hike by the Fed this year sits at 30%, but that could decline further and potentially drag the US dollar lower with US yields.
Were it not for the geopolitical situation, the dollar could have been at more risk of correcting a little lower this week on the prospect of softer US consumption data, however, uncertainty in the Middle East and higher energy prices should support the energy-independent dollar, keeping EUR/USD confined below $1.06 in the short term.
USD/MXN declines over 1%
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: October 16-20
Have a question? [email protected]
*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.
