EUR
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
Hawkish! This sums up the Feb ECB policy meeting. The initial statement was in line with Dec guidance and offered very little surprises (which was initially seen as dovish). However, during the press conference President Lagarde explained that the upside surprises in CPI in Dec and Jan saw unanimous concern around the GC in the near-term and surprised markets by not repeating Dec language which said a 2022 rate hike was unlikely (which immediately saw STIR markets price in a 10bsp hike as soon as June). The president also made the March meeting live, by stating that they’ll use the March meeting to decide what the APP will look like for the rest of 2022 (which markets took as a signal that the APP could conclude somewhere in 2H22. After the meeting we had the customary sources comments which stated that the ECB is preparing for a potential policy recalibration in March (with some members wanting to change policy at today’s meeting already) and added that it is sensible not to exclude a 2022 hike as a possibility and also stated that the ECB is considering possibly ending the APP at the end of Q3 (which would put a Q4 hike in play). Furthermore, sources stated that if inflation does not ease, they’ll consider adjusting policy in March (which means incoming inflation data will be critical). The shift is stance and tone were significant for us to change the bank’s overall policy stance to neutral and to adjust the EUR’s fundamental bias from dovish to neutral as well. Incoming inflation data will be key from here.
2. Economic & Health Developments
Recent activity data suggests the hit from lockdowns weren’t as bad as feared, the Omicron restrictions weighed on growth. Differentials still favour the US and UK above the EZ. The big focus though is on the incoming inflation data after the ECB’s recent hawkish pivot at their Feb meeting. On the fiscal front, attention is on ongoing discussions to potentially allow purchases of ‘green bonds’ NOT to count against budget deficits. If approved, this can drastically change the fiscal landscape and would be a positive for the EUR and EU equities.
3. Funding Characteristics
As a low yielder (like JPY & CHF), the EUR has been a funding choice among carry trades, especially against high yielding EM. As more central banks start normalizing policy and rate differentials widen, the EUR’s use as a funding currency could add additional pressure in the med-term, but if rates start moving closer to 0% in line with rate expectations that could change some of that funding attractiveness.
4. CFTC Analysis
The big gain in large speculator net-longs was mostly belated upside from the Feb ECB meeting as the reference weeks was only included in Friday’s update. Even though we think the number of negatives priced for the EUR can still see some upside, the corroborated comments from various ECB members to push back against the market’s hawkish take did take us out of our remaining EURGBP long and means we are staying patient with the EUR until we get more clarity on the data front or additional hawkish comments from the ECB.
5. The Week Ahead
Very quiet week ahead on the data front for the Eurozone with German ZEW data the only data point of note. After the ECB’s Feb meeting, we’ve had both President Lagarde and ECB’s Villeroy trying to reign in some of the aggressive moves in European bond yields. Even though their push back against the market’s hawkish interpretation of the Feb press conference, we can see STIR markets are still comfortable in pricing in 50bsp of tightening for the ECB by year-end. Thus, even though the EUR caught some downside as a result of the push back, as long as market expectations for rate hikes and a possible March policy recalibration remains intact, that should put a short-term floor under the EUR, at least until we get the next batch of HICP data on the 2nd of March. This also means that incoming ECB speak in the week ahead will probably be the most important driver, with further hawkish comments arguably being able to see outsized moves in the EUR as opposed to dovish comments.
GBP
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
Hawkish surprise with a hint of dovish undertones sums up the Feb BoE decision. The bank announced the start of passive QT and hiked rates by 25bsp as expected, but the vote split was unanimous (9-0) but with a big hawkish surprise being 4 MPC members voting for a 50bsp hike. Inflation forecasts saw a big upward revision to a 7.25% peak by April ( prev . 6.0%) & 5.21% in 1-year ( prev . 3.40%). This initial hawkish statement saw immediate strength for GBP but during the press conference the BoE tried their best to get a dovish landing. Gov Bailey started his opening remarks by noting that the MPC’s decision to hike was not because the economy
was strong but only because higher rates were necessary to return inflation to target, and even though he opened the door for further hikes he added that markets should not assume rates are on a long march higher. He also acknowledged the stagflation fears recently voiced by some market participants by saying that policy faces a trade-off between weakening growth and higher inflation . Despite the dovish nuances, STIR markets still price an implied cash rate of 1.0% by May which would mean a 25bsp in both March and May (1.0% is the level the BoE previously said they would being outright Gilt selling). Overall, the statement was hawkish, but the clear dovish undertones from the BoE was a bit surprising and also a bit worrisome for the future outlook.
2. Economic & Health Developments
Even though growth estimates for the UK remain on solid footing, not everyone shares that optimism (Refinitiv polling data). With inflation the main reason for the BoE’s recent rate hikes, there is a concern that the UK economy faces a risk of stagflation, with inflation staying sticky while growth decelerates. That also means that current market expectations for rates looks way too aggressive and means downside risks for GBP should growth data push lower and inflation data stay high or even accelerate from here.
3. Political Developments
Domestic political uncertainty usually leads to higher risk premiumsfor GBP, so the fate of PM Johnson remains a focus. Fallout from the heavily redacted Sue Gray report was limited but with growing distrust from within his party the question remains whether a vote of no-confidence will happen (if so, that could see short-term downside), and then focus will be on whether the PM can survive an actual vote of no-confidence, where a win should be GBP positive and negative for GBP if he loses. The Northern Ireland protocol is still in focus with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now,
markets have rightly ignored this as posturing, but any actual escalation can see sharp downside for GBP.
4. CFTC Analysis
The confusion from last week’s COT data for Sterling has not been resolved with the recent print, showing a very sizeable increase in net-longs just as the GBP saw quite a jolt lower. With the recent ups and downs in CFTC data for Sterling it might be best not to make too much of the swings until they form a steady trend.
5. The Week Ahead
In the UK we have an important batch of Jan data with jobs, CPI and retail sales. For jobs, the focus will fall predominantly on wages with the BoE voicing concerns that domestic cost pressures have been driven by a tight labour market. Thus, a big miss or beat in earnings can create short-term volatility for Sterling. For CPI , consensus expects the MM measures to contract while YY headline is expected flat and a slight increase for YY Core. It’s important to keep in mind that the BoE have projected a CPI peak of 7.25% in April and a print around 6% for Feb and March, which means it would take a number north of 6% to spark more concerns from the BoE. For Retail Sales, consensus expects a bounce in Jan of 0.6%, up from the dismal Dec print of -3.7%. Analysts point to a ‘post-Black Friday’ pullback and Omicron as the main culprits for the miss in Dec, which means a bounce in Jan should make sense if that was the case. With growing ‘stagflation’ concerns for the UK among market participants, a further miss would not bode well for the growth outlook.
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
Hawkish! This sums up the Feb ECB policy meeting. The initial statement was in line with Dec guidance and offered very little surprises (which was initially seen as dovish). However, during the press conference President Lagarde explained that the upside surprises in CPI in Dec and Jan saw unanimous concern around the GC in the near-term and surprised markets by not repeating Dec language which said a 2022 rate hike was unlikely (which immediately saw STIR markets price in a 10bsp hike as soon as June). The president also made the March meeting live, by stating that they’ll use the March meeting to decide what the APP will look like for the rest of 2022 (which markets took as a signal that the APP could conclude somewhere in 2H22. After the meeting we had the customary sources comments which stated that the ECB is preparing for a potential policy recalibration in March (with some members wanting to change policy at today’s meeting already) and added that it is sensible not to exclude a 2022 hike as a possibility and also stated that the ECB is considering possibly ending the APP at the end of Q3 (which would put a Q4 hike in play). Furthermore, sources stated that if inflation does not ease, they’ll consider adjusting policy in March (which means incoming inflation data will be critical). The shift is stance and tone were significant for us to change the bank’s overall policy stance to neutral and to adjust the EUR’s fundamental bias from dovish to neutral as well. Incoming inflation data will be key from here.
2. Economic & Health Developments
Recent activity data suggests the hit from lockdowns weren’t as bad as feared, the Omicron restrictions weighed on growth. Differentials still favour the US and UK above the EZ. The big focus though is on the incoming inflation data after the ECB’s recent hawkish pivot at their Feb meeting. On the fiscal front, attention is on ongoing discussions to potentially allow purchases of ‘green bonds’ NOT to count against budget deficits. If approved, this can drastically change the fiscal landscape and would be a positive for the EUR and EU equities.
3. Funding Characteristics
As a low yielder (like JPY & CHF), the EUR has been a funding choice among carry trades, especially against high yielding EM. As more central banks start normalizing policy and rate differentials widen, the EUR’s use as a funding currency could add additional pressure in the med-term, but if rates start moving closer to 0% in line with rate expectations that could change some of that funding attractiveness.
4. CFTC Analysis
The big gain in large speculator net-longs was mostly belated upside from the Feb ECB meeting as the reference weeks was only included in Friday’s update. Even though we think the number of negatives priced for the EUR can still see some upside, the corroborated comments from various ECB members to push back against the market’s hawkish take did take us out of our remaining EURGBP long and means we are staying patient with the EUR until we get more clarity on the data front or additional hawkish comments from the ECB.
5. The Week Ahead
Very quiet week ahead on the data front for the Eurozone with German ZEW data the only data point of note. After the ECB’s Feb meeting, we’ve had both President Lagarde and ECB’s Villeroy trying to reign in some of the aggressive moves in European bond yields. Even though their push back against the market’s hawkish interpretation of the Feb press conference, we can see STIR markets are still comfortable in pricing in 50bsp of tightening for the ECB by year-end. Thus, even though the EUR caught some downside as a result of the push back, as long as market expectations for rate hikes and a possible March policy recalibration remains intact, that should put a short-term floor under the EUR, at least until we get the next batch of HICP data on the 2nd of March. This also means that incoming ECB speak in the week ahead will probably be the most important driver, with further hawkish comments arguably being able to see outsized moves in the EUR as opposed to dovish comments.
GBP
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
Hawkish surprise with a hint of dovish undertones sums up the Feb BoE decision. The bank announced the start of passive QT and hiked rates by 25bsp as expected, but the vote split was unanimous (9-0) but with a big hawkish surprise being 4 MPC members voting for a 50bsp hike. Inflation forecasts saw a big upward revision to a 7.25% peak by April ( prev . 6.0%) & 5.21% in 1-year ( prev . 3.40%). This initial hawkish statement saw immediate strength for GBP but during the press conference the BoE tried their best to get a dovish landing. Gov Bailey started his opening remarks by noting that the MPC’s decision to hike was not because the economy
was strong but only because higher rates were necessary to return inflation to target, and even though he opened the door for further hikes he added that markets should not assume rates are on a long march higher. He also acknowledged the stagflation fears recently voiced by some market participants by saying that policy faces a trade-off between weakening growth and higher inflation . Despite the dovish nuances, STIR markets still price an implied cash rate of 1.0% by May which would mean a 25bsp in both March and May (1.0% is the level the BoE previously said they would being outright Gilt selling). Overall, the statement was hawkish, but the clear dovish undertones from the BoE was a bit surprising and also a bit worrisome for the future outlook.
2. Economic & Health Developments
Even though growth estimates for the UK remain on solid footing, not everyone shares that optimism (Refinitiv polling data). With inflation the main reason for the BoE’s recent rate hikes, there is a concern that the UK economy faces a risk of stagflation, with inflation staying sticky while growth decelerates. That also means that current market expectations for rates looks way too aggressive and means downside risks for GBP should growth data push lower and inflation data stay high or even accelerate from here.
3. Political Developments
Domestic political uncertainty usually leads to higher risk premiumsfor GBP, so the fate of PM Johnson remains a focus. Fallout from the heavily redacted Sue Gray report was limited but with growing distrust from within his party the question remains whether a vote of no-confidence will happen (if so, that could see short-term downside), and then focus will be on whether the PM can survive an actual vote of no-confidence, where a win should be GBP positive and negative for GBP if he loses. The Northern Ireland protocol is still in focus with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now,
markets have rightly ignored this as posturing, but any actual escalation can see sharp downside for GBP.
4. CFTC Analysis
The confusion from last week’s COT data for Sterling has not been resolved with the recent print, showing a very sizeable increase in net-longs just as the GBP saw quite a jolt lower. With the recent ups and downs in CFTC data for Sterling it might be best not to make too much of the swings until they form a steady trend.
5. The Week Ahead
In the UK we have an important batch of Jan data with jobs, CPI and retail sales. For jobs, the focus will fall predominantly on wages with the BoE voicing concerns that domestic cost pressures have been driven by a tight labour market. Thus, a big miss or beat in earnings can create short-term volatility for Sterling. For CPI , consensus expects the MM measures to contract while YY headline is expected flat and a slight increase for YY Core. It’s important to keep in mind that the BoE have projected a CPI peak of 7.25% in April and a print around 6% for Feb and March, which means it would take a number north of 6% to spark more concerns from the BoE. For Retail Sales, consensus expects a bounce in Jan of 0.6%, up from the dismal Dec print of -3.7%. Analysts point to a ‘post-Black Friday’ pullback and Omicron as the main culprits for the miss in Dec, which means a bounce in Jan should make sense if that was the case. With growing ‘stagflation’ concerns for the UK among market participants, a further miss would not bode well for the growth outlook.