Written by Convera’s Market Insights team
Too many tailwinds for dollar
George Vessey – Lead FX Strategist
With the steady inflow of good news about the US economy in recent weeks, the US economic surprise index is now at its highest since April. Risks have skewed toward the Federal Reserve (Fed) delivering less rate cuts as a result, sending US yields and the US dollar index to 2-month highs, the latter clocking its third consecutive weekly gain.
Robust US retail sales in September, along with strong jobs and inflation reports earlier this month, indicated resilient consumer spending and suggest the US economy remains far from recession and instead is positioning for another strong quarter of growth. The big difference between the US and most other economies has been a drop in savings compared with the pre-pandemic period. US spending has recovered to its previous trend level compared to consumption in the Eurozone, Japan and the UK, which have been flat. Indeed, US consumers are seen as a key pillar to continued USD strength because it boosts hopes of a soft or no landing and it also reduces the Fed’s easing scope. Thus, traders are now pricing in only 40 basis points of rate cuts for November and December, compared to over 70bps a month ago.
Additionally, the prospect of Donald Trump winning the presidential election is further supporting the dollar as his policies on tariffs, taxes and immigration are seen as inflationary, potentially meaning the Fed maintains interest rates higher for longer. We see a Republican clean sweep as the biggest volatility risk as traders start placing election trades with greater conviction over the next two weeks.
The risk for GBP/USD is skewed lower
George Vessey – Lead FX Strategist
The pound dropped below $1.30 to its lowest level in over two months against the US dollar last week, largely due to USD strength, but also after UK wage and inflation data raised bets of Bank of England (BoE) rate cuts. Friday’s UK retail sales report threw sterling a lifeline though, sending GBP/USD back above $1.30 whilst GBP/EUR stretched to fresh 2-year highs beyond €1.20, a level its only been above for 3% of the post-Brexit period.
Thanks to the ECB rate cut and more cuts expected, the UK-German 2-year swap differential has been moving higher, helping GBP/EUR climb. Widening growth differentials in favour of the UK provide the pound another tailwind versus the common currency. However, the outlook for GBP/USD is less certain. Sterling may not be a default expression of Trump tariff risk, but after last week’s UK data and with the UK Budget looming, gilts have been in high demand, outperforming many developed peers. Thus, with UK-US 10-year yield spreads moving from +22bps to -2bps over the past month, a continued to decline could drag GBP/USD back under $1.30 again soon.
Over the long-term though, especially if the Democrats win the US election, we still favour the pound extending back towards $1.35 next year assuming US economic growth starts to cool and the Fed cuts interest rates more than the BoE. However, as per our US election guide, a tail risk scenario of a Republican clean sweep is seen sending GBP/USD under $1.25, even before year-end.
China to the rescue
Boris Kovacevic – Global Macro Strategist
The common currency continues to be driven heavily by external factors, which have helped EUR/USD trim some of its weekly losses on Friday. Risk appetite was high going into the weekend following another round of stimulus from China. EUR/USD recovered from its brief dip to $1.0810 and ended the trading session around $1.0860. The currency was still down over the week as US election nerves boosted the greenback, pressuring the EUR/USD, while another interest rate cut from the European Central Bank (ECB) also weighed on the single currency. The ECB cut its deposit rate by 25bps to 3.25% in a widely expected move.
ECB president Christine Lagarde’s downbeat assessment of the European economy – saying growth has been weaker than expected – caused markets to speculate the ECB will need to cut rates further. Global money markets repositioned after the ECB decision with the Eurozone now expected to cut interest rates more sharply than the US or UK. Financial markets are now looking for more than 175bps of cuts from the ECB over the next 12 months.
With the central bank meetings out of the way until November and December, focus will shift to the upcoming macro data. The release of the purchasing manager indices for most European countries, Eurozone consumer confidence and the German Ifo business climate will be key for markets. ECB president Christine Lagarde has three speeches scheduled this week as well. On the political side, we will be watching out for the sovereign debt updates for France (Moody’s) and Italy (DBRS).
Equities and gold thrive as US election looms
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: October 21-25
All times are in BST
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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
