Written by Convera’s Market Insights team
Three implications from two weeks of war
Boris Kovacevic – Global Macro Strategist
The global news flow of the past two weeks can broadly be divided into the following three categories: (1) geopolitical developments, (2) central bank speeches, and (3) macroeconomic data releases. Two weeks into the war between Hamas and Israel and just before the upcoming rate decisions by the G3 central banks, investors are trying to gauge both the probability of further geopolitical escalations and the chances of continued rate hikes in the developed world.
The interim conclusion of the initial impact of the conflict in the Middle East, the plethora of central bank speeches and recent macro data has been that: (1) investors switched to a more risk-averse position, favoring safe-havens assets, (2) investors decreased their bets of further rate hikes, (3) while pushing out their expectations for the first rate cuts by the G3 central banks well into 2024 given strong US data and signs that the Chinese economy might be bottoming. The higher for longer narrative has finally taken hold in markets. Last week, industrial production, retail sales and new home sales came in better than expected, showing how the US economy is not weakening as fast as expected.
The US dollar has been benefiting from its trifecta status as a high yielder, safe haven and high growth currency, but has struggled to convincingly build on its gains and (DXY) and has stagnated for a month now. This is surprising given rising tensions in the Middle East, Treasury yields climbing to fresh cycle highs and persistently strong US economic data. With the Fed at, or close to, the end of its hiking cycle and the DXY 14% above its long-term (2000) mean, the dollar could react more forcefully to negative data surprises than positive ones from here.
Big week for Europe – is the continent bottoming?
Boris Kovacevic – Global Macro Strategist
As with the US and China, European macro data surprised to the upside last week. The ZEW barometer for how investors assess the prospect of the German and Eurozone economy rose in both regions to the highest level since April, creating hopes for a bottoming of European growth. Companies in the Eurozone also increased industrial production by more than expected in August, with the boost in durable consumer goods driving the rise. We are still looking for signs of a clear bottom in China and Europe.
Still, the likelihood of Germany entering a second recession this year has nonetheless increased in the recent weeks. Europe’s largest economy is set to record negative growth in the two final quarters of this year. Markets have pushed down their expectation of any rate hikes by the ECB this year with the consensus seeing the first easing of policy in July 2024. Looking at the positioning on markets right now, Equity markets on both sides of the Atlantic fell on the week. The S&P500, FTSE 100 and Stoxx 600 are now 7.5%, 7.2% and 11% away from their yearly respective highs. The German DAX is currently trading at a 7-month low with EUR/USD at $1.0570.
Investors continue to position themselves more cautiously, as the higher for longer narrative sets in and geopolitical tensions spread. With the yen and yuan close to intervention level, the Swiss franc at historic highs and the dollar bid less than expected, currency markets remain volatile. The upcoming week will continue to be dominated by macro data and the news flow from the Middle East. Focus will fall on primary European data, concluding with the ECB rate decision on Thursday. In all our main regions, Flash PMIs will be published as the first data points for the month of October.
Risk-sensitive sterling suffers
George Vessey – Lead FX Strategist
Whilst safe haven demand boosted the Swiss franc last week, the risk-sensitive British pound came under selling pressure amid geopolitical tensions, poor corporate earnings and rising US yields. Meanwhile, a string of poor UK economic data also weighed on sterling, with questions raised about the accuracy of some UK labour market data, including wage growth. GBP/EUR fell to its lowest level in five months and remains anchored below €1.15 today.
Domestic data triggered some GBP volatility last week. Slightly softer wage growth data and slightly above-forecast inflation data did little to influence the market pricing of Bank of England (BoE) interest rate expectations. But with consumer confidence data on Friday slumping to a 3-month low and retail sales worse than forecasts, the probability of another BoE hike this year dropped from 50% to 30%, which dragged sterling lower across the board. Tomorrow, all eyes will be on the postponed UK employment data as well as flash PMIs for October, which is expected to suggest a milder contraction in both manufacturing and services sectors. All data points will be closely watched by policymakers and investors as usual, but GBP price action will also be driven by global risk sentiment as GBP/USD has one of highest positive correlations with the S&P 500 out of the majors.
Although GBP/USD managed to scrape a weekly rise in the end, if risk aversion continues to dominate, we expect risks to remain skewed to the downside for the pound, with the psychologically important $1.20 level a key downside target but also likely a big support level in the near-term.
Swissy shines on safe haven demand
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: October 23-27
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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.
