Written by Convera’s Market Insights team
New volatility catalyst
Boris Kovacevic – Global Macro Strategist
Global markets have worked through their largest drawdown so far this year and have made up all the losses from last Monday’s historic sell-off. Still, equities seem more vulnerable and data dependent than before the US jobs report and volatility rates remain elevated. Protecting against further downside on the options market is as expensive as it was a year ago, although the unwinding of the carry trade via the closing of short-yen positioning continues. The main take-away from recent developments is that the popular and extended trades of 2024 are no longer a one-way street up. Investors will cautiously watch over incoming macro data to gauge just how much the Federal Reserve will cut interest rates in September and beyond.
The first test for the current recovery rally comes in the form of US inflation. Both headline and core CPI are expected to ease further on an annual basis, falling from 3.0% to 2.9% and from 3.3% to 3.2%, respectively. Producer price inflation should be soft as well and we therefore think that, absent any upside surprises, the inflation numbers should be benign and well received by investors. This will shift the focus to US retail sales, which are expected to rise from 0% to 0.4% in July. Anecdotal evidence from earnings calls, cooling wage growth, an easing labour market and rising delinquency rates are highlighting the rising sensitivity of the consumer to a weakening growth environment. However, the actual spending data remains strong.
The dollar index has erased its losses from last Monday and was flat last week but aappears to be in a more vulnerable position in light of global events. Its softening rate advantage bolsters the case for weakness against pro-cyclical peers, especially assuming further stabilisation in risk sentiment. Looking ahead, inflation and retail sales data from the US will test this thesis but barring any upside surprises or more global market turmoil, the path of least resistance appears lower.
Data deluge to determine pound’s direction
George Vessey – Lead FX Strategist
Movements in the pound over recent weeks highlight its vulnerability to global dynamics. Domestic unrest and looming tax hikes have dampened the post-election optimism, causing sterling to depreciate for four straight weeks from around $1.30 to $1.27 versus the USD. Additionally, the broader market turbulence has underscored the pound’s sensitivity to risk sentiment, leading it to swing wildly against other safe haven peers like the JPY and CHF.
Notably, the UK currency has been the worst performer among its G10 counterparts in August, experiencing its steepest two-week decline against the euro since early 2023. Rate differentials had indicated that sterling was overvalued against the euro, so it’s not surprising to see GBP/EUR adjust to a more balanced level around €1.17. However, the 1-year UK-US rate differentials suggest that the pound’s 3% drop against the dollar since mid-July may be overdone. Indeed, the downward momentum has slowed near the 100-day and 200-day moving averages, rebounding around a cent from $1.27 to trade nearer its 5-year average of $1.28. Sterling needs a new positive catalyst to resume its upward trajectory from the first half of 2024 though. This week’s slew of UK data might provide that trigger or perhaps weigh further on the UK currency if it boosts bets of more Bank of England (BoE) rate cuts.
The upcoming UK inflation, wage growth and GDP data for Q2 could be crucial, especially if it leads to a meaningful repricing of BoE rate expectations. Currently, less than two more quarter point cuts are priced in for 2024, with only a 34% probability of one being delivered in September.
Euro remains in a consolidation mode above $1.09
Ruta Prieskienyte – Lead FX Strategist
Last week, we observed a brief euro rally to an 8-month high, driven by a softer US economic outlook and a shift in safe-haven demand, which was swiftly faded at the $1.10 threshold. European Stoxx50 marginally rebounded on the week but remains over 4% down MTD. Amid steadier risk sentiment, Bunds consolidated recording a first weekly loss in five.
The market appears to be treading carefully with the EUR/USD pair, particularly as we approach the release of the US CPI data this week. While a move back towards the $1.10 level is still on the table, the broader tactical outlook for the euro over the next three months remains bearish. This sentiment is underpinned by further scaling back of Fed easing expectations, as the current pricing remains rich when compared to the historical Fed easing cadence. Compounding the euro’s challenges is the broader weakening in global growth prospects. The fundamentals continue to remain largely non-euro supportive. In addition to deteriorating macro data over the past 2-months, Friday’s Germany data showed insolvencies rising to by almost 30% YoY in May, which is now on track to breach a level last seen in 2017.
The political risks within Europe and in the US add another layer of uncertainty, potentially exerting additional downward pressure on the euro. In fact, the 1m3m implied vol spread, which encompasses the Fed, ECB rate decisions as well as US election risk events, has shot up to a 2-year high as of recently.
Safe havens under pressure as risk sentiment improves
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: August 12-16
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.
