GBP
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
They did it again! After leading markets to believe that a Dec hike was unlikely, the BoE wrong footed markets again with their 15bsp hike. Recall that BoE’s Saunders (who voted for a Nov hike) suggested there could be benefits in waiting before moving on rates, and BoE’s Mann said it was premature to even talk about the timing of hikes let alone the magnitude, but of course both of them ended up voting for a hike with a surprising 8-1 vote split (BoE’s Tenreyro only dissenter). The BoE lost even more of the little credibility it had left, but they did the right thing (in my opinion at least) as they stayed data dependent and hiked given a flurry of much better-than-expected econ data. The consensus view among the MPC was that inflation warranted tighter policy in the near-term, but still expects CPI to peak close to 6% in April (up from prev. projections). One negative was with growth, which is expected to push lower given the Omicron wave.
2. Economic & Health Developments
There is a growing chorus of participants calling for a very tough road ahead for UK growth, and most recent Retail Sales data gave more confirmation to this expectation. Forecasts by the IMF/OECB still sees decent growth differentials, but not everyone shares that optimism (Refinitiv polling data). Even though the solid econ data going into Dec was enough to see the BoE hike, the overall rate expectations already priced in by markets are too ambitious and we think the BoE risks disappointing. As long incoming data stays solid it should keep odds for additional tightening alive, but we should be mindful of a potential unwinding and repricing if the
incoming data starts confirming a bleaker picture.
3. Political Developments
Even though Brexit isn’t in focus as it used to be (thank goodness), there are some remaining issues such as the Northern Ireland protocol. For now, the 2 sides have not budged with punchy rhetoric from both sides with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, markets have ignored this as political posturing, but of course any actual escalation could see sharp risk premium built into the GBP. Political uncertainty for PM Johnson opens up further caution as GBP usually struggles with domestic political uncertainty. Thus, the Sue Gray report and fallout from it is in focus, where damaging results for the PM could prove GBP negative and vice versa if it shows the PM is not at fault. Apart from that, the question remains whether enough MP’s opt for a vote of no-confidence (if so, that could see short-term downside), but after that the focus will be on whether the PM can survive an actual vote of noconfidence, where a win is expected to be GBP positive and negative for Sterling if he loses.
4. CFTC Analysis
Latest CFTC data showed a positioning change of -7516 with a net non-commercial position of -7763. Leveraged funds (net-long) and large specs (net-short) are at odds with recent positioning update. However, with both still relatively close to neutral territory it does not tell us much about overall sentiment for Sterling.
5. The Week Ahead
Thursday’s BoE meeting will be the biggest focus for the GBP this week. A recent Reuters Poll showed that 29/45 (>60%) of economists surveyed expect a 25bsp hike, while STIR market odds are close to 90%. Even though recent Retail Sales data were disappointing, headline CPI YY rose to 5.4% (0.9bsp above MPR projections) and Unemployment fell to 4.1% and showed that the phase out of the furlough scheme had a very small impact on the labour market. Thus, on the data front alone a hike seems reasonable. We also had comments from Gov Bailey who noted concerns about possible second-round effects from inflation on wages and comments from BoE’s Mann that noted monetary policy needs to temper 2022 inflation and wage expectations to prevent them from becoming embedded in the decision-making for firms and consumers, both of these comments added to the odds of a hike. Apart from a hike though, expectations of slower-thanexpected growth will be in focus as well as a much bleaker outlook could see doubt of the current rate path brought into focus. The APF will also be in focus as the BoE said they will halt reinvestments under the APF once they reach a cash rate of 0.50% so comments on that will also be important to watch.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Jan FOMC decision was hawkish on multiple fronts. The statement signalled a March hike as expected, but the press conference from Chair Powell portrayed a very hawkish message. Even though Powell said they can’t predict the rate path with certainty, he stressed the economy is in much better shape compared to the 2015 cycle and that will have implications for the pace of hikes. Furthermore, the Chair explained that there is ‘quite a bit of room’ to raise rates without dampening employment, which suggests upside risks to the rate path, especially coming from Powell. A big question markets wanted an answer for was whether the Fed was
concerned about recent equity market volatility . However, the Chair explained that markets and financial conditions are reflecting policy in advance and stressed that in aggregate their measures they look at is not showing red lights. This was a clear message to markets that any ‘Fed Put’ is much further away and that inflation is the biggest focus point for the Fed right now. The Chair also didn’t rule out the possibility of hiking 50bsp in March or possibly hiking at every meeting this year, which was seen as hawkish as it means the Fed is looking for optionality to move more aggressive if they need to. On the balance sheet , we didn’t really get new info and the Chair reiterated that they are contemplating a start of QT after the hiking cycle has begun but also reiterated that they will discuss this in coming meetings. Overall, the tone and language used by the Chair were a lot more hawkish than the Dec meeting and more hawkish than some were hoping for.
2. Global & Domestic Economy
As the reserve currency, the USD’s usage around the world means it usually has an inverse correlation to the health of the global economy and global trade. The USD usually gains strength when growth & inflation both slow (disinflation) and loses ground when growth & inflation accelerates (reflation). Thus, with expectations that both growth and inflation will decelerate this year, both in the US and the globe, that should be a positive input for the USD in the med-term . However, incoming data will also be important in relation to the ‘Fed Put’. There are many similarities between now and 4Q18, where the Fed were also tightening aggressively going into an economic slowdown. So, incoming data will be crucial to watch. As long as growth data slows and the Fed stays aggressive that would be a positive environment for the USD, but if it causes the Fed to pivot more dovish and causes a rate repricing in money markets it would be seen as a negative input for the USD.
3. CFTC Analysis
Latest CFTC data showed a positioning change of +427 with a net non-commercial position of +36861. The shortterm unwinding of stretched USD longs played out as expected at the start of the year but was also short-lived in the midst of the recent strong risk off sentiment in certain parts of the market and of course the continued hawkish stance from the Fed.
4. The Week Ahead
In the week ahead the party starts all over again with a new month which means we’ll get new ISM PMI releases as well as the Jan NFP report. It’s important to keep the current economic climate in mind when looking at possible reaction functions for the USD. Usually, positive data should be USD positive and negative data USD negative when the Fed is busy with a hiking cycle, but right now there are growing fears that economic data has been slowing much faster than expected and means the Fed could be on its way to make the same mistake it did back in the end of 2018. As long as those fears persist, we might see the USD having two different reaction functions to growth and inflation data. Reacting inverse to growth data but acting correlated to inflation data. That makes this week’s incoming ISM data very interesting as the Dec data decelerated much faster than expected on the growth side, and a further miss might spark more fears about a faster slowdown. The tricky part for the USD in the week ahead is that both the ISM prints as well as the NFP report has inflation components with the ISM priced paid components and the Average Hourly Earnings on the NFP side. If growth data slows very fast that could be USD positive, but if inflation data starts decelerating much faster that could also be USD negative as it means less need for aggressive Fed policy. A tricky one for the week ahead.
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
They did it again! After leading markets to believe that a Dec hike was unlikely, the BoE wrong footed markets again with their 15bsp hike. Recall that BoE’s Saunders (who voted for a Nov hike) suggested there could be benefits in waiting before moving on rates, and BoE’s Mann said it was premature to even talk about the timing of hikes let alone the magnitude, but of course both of them ended up voting for a hike with a surprising 8-1 vote split (BoE’s Tenreyro only dissenter). The BoE lost even more of the little credibility it had left, but they did the right thing (in my opinion at least) as they stayed data dependent and hiked given a flurry of much better-than-expected econ data. The consensus view among the MPC was that inflation warranted tighter policy in the near-term, but still expects CPI to peak close to 6% in April (up from prev. projections). One negative was with growth, which is expected to push lower given the Omicron wave.
2. Economic & Health Developments
There is a growing chorus of participants calling for a very tough road ahead for UK growth, and most recent Retail Sales data gave more confirmation to this expectation. Forecasts by the IMF/OECB still sees decent growth differentials, but not everyone shares that optimism (Refinitiv polling data). Even though the solid econ data going into Dec was enough to see the BoE hike, the overall rate expectations already priced in by markets are too ambitious and we think the BoE risks disappointing. As long incoming data stays solid it should keep odds for additional tightening alive, but we should be mindful of a potential unwinding and repricing if the
incoming data starts confirming a bleaker picture.
3. Political Developments
Even though Brexit isn’t in focus as it used to be (thank goodness), there are some remaining issues such as the Northern Ireland protocol. For now, the 2 sides have not budged with punchy rhetoric from both sides with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, markets have ignored this as political posturing, but of course any actual escalation could see sharp risk premium built into the GBP. Political uncertainty for PM Johnson opens up further caution as GBP usually struggles with domestic political uncertainty. Thus, the Sue Gray report and fallout from it is in focus, where damaging results for the PM could prove GBP negative and vice versa if it shows the PM is not at fault. Apart from that, the question remains whether enough MP’s opt for a vote of no-confidence (if so, that could see short-term downside), but after that the focus will be on whether the PM can survive an actual vote of noconfidence, where a win is expected to be GBP positive and negative for Sterling if he loses.
4. CFTC Analysis
Latest CFTC data showed a positioning change of -7516 with a net non-commercial position of -7763. Leveraged funds (net-long) and large specs (net-short) are at odds with recent positioning update. However, with both still relatively close to neutral territory it does not tell us much about overall sentiment for Sterling.
5. The Week Ahead
Thursday’s BoE meeting will be the biggest focus for the GBP this week. A recent Reuters Poll showed that 29/45 (>60%) of economists surveyed expect a 25bsp hike, while STIR market odds are close to 90%. Even though recent Retail Sales data were disappointing, headline CPI YY rose to 5.4% (0.9bsp above MPR projections) and Unemployment fell to 4.1% and showed that the phase out of the furlough scheme had a very small impact on the labour market. Thus, on the data front alone a hike seems reasonable. We also had comments from Gov Bailey who noted concerns about possible second-round effects from inflation on wages and comments from BoE’s Mann that noted monetary policy needs to temper 2022 inflation and wage expectations to prevent them from becoming embedded in the decision-making for firms and consumers, both of these comments added to the odds of a hike. Apart from a hike though, expectations of slower-thanexpected growth will be in focus as well as a much bleaker outlook could see doubt of the current rate path brought into focus. The APF will also be in focus as the BoE said they will halt reinvestments under the APF once they reach a cash rate of 0.50% so comments on that will also be important to watch.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Jan FOMC decision was hawkish on multiple fronts. The statement signalled a March hike as expected, but the press conference from Chair Powell portrayed a very hawkish message. Even though Powell said they can’t predict the rate path with certainty, he stressed the economy is in much better shape compared to the 2015 cycle and that will have implications for the pace of hikes. Furthermore, the Chair explained that there is ‘quite a bit of room’ to raise rates without dampening employment, which suggests upside risks to the rate path, especially coming from Powell. A big question markets wanted an answer for was whether the Fed was
concerned about recent equity market volatility . However, the Chair explained that markets and financial conditions are reflecting policy in advance and stressed that in aggregate their measures they look at is not showing red lights. This was a clear message to markets that any ‘Fed Put’ is much further away and that inflation is the biggest focus point for the Fed right now. The Chair also didn’t rule out the possibility of hiking 50bsp in March or possibly hiking at every meeting this year, which was seen as hawkish as it means the Fed is looking for optionality to move more aggressive if they need to. On the balance sheet , we didn’t really get new info and the Chair reiterated that they are contemplating a start of QT after the hiking cycle has begun but also reiterated that they will discuss this in coming meetings. Overall, the tone and language used by the Chair were a lot more hawkish than the Dec meeting and more hawkish than some were hoping for.
2. Global & Domestic Economy
As the reserve currency, the USD’s usage around the world means it usually has an inverse correlation to the health of the global economy and global trade. The USD usually gains strength when growth & inflation both slow (disinflation) and loses ground when growth & inflation accelerates (reflation). Thus, with expectations that both growth and inflation will decelerate this year, both in the US and the globe, that should be a positive input for the USD in the med-term . However, incoming data will also be important in relation to the ‘Fed Put’. There are many similarities between now and 4Q18, where the Fed were also tightening aggressively going into an economic slowdown. So, incoming data will be crucial to watch. As long as growth data slows and the Fed stays aggressive that would be a positive environment for the USD, but if it causes the Fed to pivot more dovish and causes a rate repricing in money markets it would be seen as a negative input for the USD.
3. CFTC Analysis
Latest CFTC data showed a positioning change of +427 with a net non-commercial position of +36861. The shortterm unwinding of stretched USD longs played out as expected at the start of the year but was also short-lived in the midst of the recent strong risk off sentiment in certain parts of the market and of course the continued hawkish stance from the Fed.
4. The Week Ahead
In the week ahead the party starts all over again with a new month which means we’ll get new ISM PMI releases as well as the Jan NFP report. It’s important to keep the current economic climate in mind when looking at possible reaction functions for the USD. Usually, positive data should be USD positive and negative data USD negative when the Fed is busy with a hiking cycle, but right now there are growing fears that economic data has been slowing much faster than expected and means the Fed could be on its way to make the same mistake it did back in the end of 2018. As long as those fears persist, we might see the USD having two different reaction functions to growth and inflation data. Reacting inverse to growth data but acting correlated to inflation data. That makes this week’s incoming ISM data very interesting as the Dec data decelerated much faster than expected on the growth side, and a further miss might spark more fears about a faster slowdown. The tricky part for the USD in the week ahead is that both the ISM prints as well as the NFP report has inflation components with the ISM priced paid components and the Average Hourly Earnings on the NFP side. If growth data slows very fast that could be USD positive, but if inflation data starts decelerating much faster that could also be USD negative as it means less need for aggressive Fed policy. A tricky one for the week ahead.