The pound’s sell off may have abated for now, but as yesterday’s prickly talks between Theresa May and Scottish leader Nicola Sturgeon highlighted, Brexit fears, and now Scoxit fears, are never too far from the surface. Today we see the governor of the Bank of England appear at the House of Lords Economic Committee at 1535 BST, which has the potential to unsettle the pound.
To cut, or not to cut, that is the question…
The markets will primarily be looking for any hints that Carney and co. at the BOE have plans to cut interest rates further. The market has pretty much priced out the prospect of a near-term rate cut from the BOE, but a dovish tone from Carney could see the market start to re-price the prospect of a cut, and the pound could take a hit.
Will he stay or will he go?
Mark Carney’s testimony comes at an interesting time, as relations between the BOE and the government remain tense after the PM appeared to criticize QE, and threaten the Bank’s independence. It also comes as Carney has two months to decide whether or not to leave the BOE in 2018, or stay on until 2021. He will make a formal announcement by the end of the year. If Carney voices concerns about the deteriorating relationship with the government, then this would be the worst outcome for the pound in our view, as the last thing an already Brexit-frazzled FX market needs now is discord between the UK authorities. It could also make it more likely that Carney will quit his post in 2018, right in the middle of the UK’s Brexit negotiations.
GBP range-bound for now, but still vulnerable
Although the sell-off in GBP has abated after the sharp decline earlier this month, the pound remains vulnerable from political forces, as we have mentioned above. GBPUSD has traded in a tight range in recent days, between 1.22 and 1.23, and volatility in this pair has fallen sharply over the course of this month. Another sell-off would likely take GBPUSD back towards 1.20 in the short term. If Carney strikes a more diplomatic tone at the House of Lords later today, then we don’t see why the current range in GBPUSD would not persist.
Dollar gets giddy with rate hike speculation
The dollar may be backing off recent highs on Tuesday, but overall we think its trend remains higher after the strongest pace of manufacturing growth for a year helped to boost expectations of a rate hike from the Federal Reserve at its December meeting. The Fed Funds Futures market is now pricing in a 70% chance of a rate hike, this time last week that was 65%. The dollar index rose to its highest level since February on Monday. Interestingly, Treasury yields did not keep pace, with the yield on the 10-Year Treasury still below the crucial 1.8% mark. If yields can play catch up, and shrug off the recent dovish tone from comments by the chair and vice-chair of the Fed, then the next leg of the dollar rally could be upon us.
China ain’t scared of no Trump
Donald Trump said on Monday that if he comes to power he will label China a currency manipulator, after USDCNH (offshore renminbi), rose to its highest ever level. We think firstly, that Trump won’t win power, and secondly, even if he does the US does not have a leg to stand on to label China a currency manipulator. Read our take here.
Teflon euro may start to show its fault lines
Last but not least, the euro may be higher on Tuesday, but until it breaks above 1.09, EURUSD remains vulnerable to further downside. It shrugged off a plethora of good news on Monday, including Portugal avoiding a junk credit rating, Spain forming a government, and positive PMI data for October. If the euro does stage a comeback then a key level of resistance is now last week’s high at 1.0972. This has something to do with German bond yields remaining extremely low, at one point on Monday the 10-Year Bund yield dipped below 0%. Without yield support it is hard to see how the euro can recover in the near term, with 1.08 being short-term support for EURUSD.
Ahead, tech stock earnings are likely to dominate, and could give US equity markets some much-needed direction ahead of the US election.
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