Written by Convera’s Market Insights team
Sterling unfazed by snap election
George Vessey – Lead FX Strategist
The big news out of the UK is that Prime Minister Rishi Sunak announced a general election to take place on July 4, much sooner than many had anticipated. Opinion polls suggest a win for the opposition Labour party, which has held a steady lead of around 20 percentage points over Mr Sunak’s Conservatives since the turn of the year. Sterling held its inflation-induced gains whilst UK gilts extended their sell off as Bank of England (BoE) rate cut bets receded further.
Sterling rallied to a 2-month high of $1.2760 against the US dollar yesterday as UK-US rate spreads narrowed after the UK inflation report moved markets. Services inflation, which the BoE pays close attention to, printed 5.9% y/y in April versus the 5.4% forecast. Recent dovish BoE rate cut bets were slashed as a result, with the odds of a June cut plunging from 50% to 10% and an August cut looking more likely. Gilt yields rose across the curve, with an almost three sigma move in the 2-year yield, rising by 15 basis points on the day – the largest daily increase in over a month. What about the election though? Well, the decision to call it early came after Sunak declared inflation was “back to normal” – referring to the slowdown in headline CPI from 11% (October 2022) to 2.3% (April 2024). The reality is that sticky services inflation might delay BoE rate cuts though, hence the market’s latest reaction. Moreover, the lack of market reaction to the snap election demonstrates how inflation and monetary policy remains more important for FX traders. Plus, most political commentators believe a Labour victory is all but a foregone conclusion. Of course, the event is not devoid of uncertainty though, GBP implied volatility for 2-month and 3-month tenures jumped to multi-week highs, while risk reversals are also becoming less pound bearish.
While markets usually prefer continuity over change, it seems a Labour government is expected to usher in a period of political stability and the prospect of a tighter relationship with the EU will help to unwind at least some of the pound’s Brexit premium. Plus, the party’s shift to a more pro-business, centre-ground position could further support sterling.
Hawkish Fed minutes lift dollar
George Vessey – Lead FX Strategist
The US dollar is still on track for its worst month of the year, rising against less than 20% of its global peers. However, the dollar index has risen for three days in a row, including its best day this month recorded yesterday following the publication of the Federal Reserve’s (Fed) meeting minutes. The dollar index rose to a one-week high with most gains made against the euro and Japanese yen, whilst sterling firmed on the UK election news.
The Fed left interest rates unchanged at 5.25%-5.50% during its last meeting and Chair Jerome Powell ruled out further rate hikes, which sent the dollar tumbling lower. However, the minutes of that meeting revealed a willingness to raise interest rates among some officials amid concerns that inflation might not decline as quickly as hoped. The faster-than-expected inflation readings in the first quarter, particularly in housing costs, shook Fed officials’ confidence levels. Moreover, a steadily growing US economy could keep consumer demand for goods and services sufficiently high to keep prices somewhat elevated. US Treasury yields rose slightly on the news, whilst equities dropped initially, but recovered on the back of a strong earnings report from Nvidia.
Today, flash Purchasing Managers Index (PMI) figures in the Eurozone, the UK and the US take centre stage, and investors will be on the lookout for whether the global growth narrative is showing signs of change.
Euro bearish tone sets in
Ruta Prieskienyte – FX Strategist
The euro retreated for the third consecutive session as the US dollar continues to advance against G10 peer group, in line with rising Treasury yields.
Just a day before a highly anticipated negotiated wage data is released for the Eurozone bloc, German wages were reported to have jumped sharply at the start of the year, casting a shadow on the ECB monetary policy easing plans for the year. Negotiated pay increased 6.2% in Q1, exceeding market consensus, although the figure includes one-off payments to compensate workers for the surging cost of living. Wage growth is one of the key metrics weighed by the central bank when deciding how much to ease monetary policy following an initial reduction in rates and the worry is that stronger-than-expected salary gains in Europe’s largest economy mean inflation will take longer to return to the 2% target. Sticky wage growth poses a fundamental risk to the disinflation process as still-high price pressure on services specifically may persist longer than expected. Despite the upside surprise, the swap implied ECB pricing remains largely unchanged with a June rate cut fully priced in and roughly 65bps of easing expected by year end. Investors remain on the sidelines ahead of the Eurozone-wide figure is released to cast judgment on year-end implications.
Across FX spot, the Swiss franc extended its decline against the euro, reaching the weakest level since April 2023, on the view that interest-rate cuts in Switzerland will continue to weigh on the currency. USD/CHF gained over 0.3% on the day, rising to a 20-day high and erasing earlier May losses. EUR/GBP fell to the lowest level since March 11 as UK inflation came in hotter than expected, pushing out BoE June rate cut hopes. Implied volatility for the pair across 2-month and 3-month tenures surged to multi-week highs after UK’s PM Rishi Sunak announced a snap election due to take place on July 4th. 3-month EUR/GBP risk reversal turned the most bearish in over a month and consequently the spread between the pair’s implied and realised vol on a 3-month tenure lifted to an 11-month high.
Pound holds at recent highs on expected Labour election win
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: May 20-24
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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.
