EUR
FUNDAMENTAL OUTLOOK: WEAK BEARISH
BASELINE
In recent weeks, the persistently high inflation has seen the ECB take a more hawkish turn with the bank hiking rates by 50bsp at their July meeting. Additional pressure on inflation from gas supply shortages and Rhine River levels in Germany means the ECB will be forced to continue hiking rates. But the bank quelled any hawkish excitement at their July meeting by explaining they are frontloading hikes and not signalling a higher terminal rate with their bigger than expected July hike. The bank also failed to ease spread fragmentation concerns with their new Transmission Protection Instrument (TPI) as the eligibility criteria means countries like Italy and Spain that will need the support the most might have a tough time qualifying. Combined with political concerns and additional inflation pressures, further spread widening looks likely for now. Right now, even though policy and spreads are important, the main story and driver for the EUR is the economic outlook. Recent growth data continues to surprise to the downside at a rapid pace and further stoking recession fears for the Eurozone. Even though the bias remains lower, a lot of negatives have been priced in from a tactical point of view so worth keeping that in mind.
POSSIBLE BULLISH SURPRISES
De-escalation or cease fire in Ukraine would open up a lot of EUR upside. Also keep Italian politics in mind where successful attempts to avoid a snap election could ease spread widening & support the EUR. Stagflation risks remains high and recent data has invigorated recession fears, but with lots of bad news priced any materially better-than-expected growth data could spark some relief. Spread fragmentation remains a concern, especially with Italian politics and the ECB’s failed attempt to reassure markets. Any TPI comments that convinces markets it can solve fragmentation issues should be supportive for the EUR. Energy supply is also in focus, which means watching gas flows from Russia. If Russia increases gas flows to more regular levels it should ease some supply concerns and see EUR upside. Rhine river concerns are one to watch, any good news on water levels and resumption of normal transport could be a bullish catalyst for the EUR.
POSSIBLE BEARISH SURPRISES
Any escalation in the Ukraine war that risks including NATO would be big negative risks. Also keep Italian politics in mind, where any failed attempts to avoid a snap election should add further pressure on the EUR. Recent data has invigorated recession fears. Even though lots of bad news is priced, any materially worse-than-expected growth data could spark further downside some relief. Spread fragmentation remains in focus, and if the ECB fails to act when we see big jolts higher in the BTP/ Bund spread, or if any TPI comment further concern markets about its effectiveness, it could trigger bearish reactions in the EUR. Energy supply is also in focus, which means watching gas flows from Russia. If Russia decreases gas flows even further, it should increase supply concerns and see EUR downside. Rhine river concerns are one to watch, any bad news on water levels and continued breakdown in transportation could be a bearish catalyst for the EUR.
BIGGER PICTURE
The fundamental outlook remains bearish with recent leading indicators pointing to a much faster economic slowdown than markets had previously expected. The current bearish drivers (geopolitics, stagflation, spread fragmentation, energy supply concerns) far outweigh the positives from a hawkish ECB. Recession risks have opened up a narrative change for the EUR which have seen markets adjust forecasts to reflect higher recession probabilities that continues to weigh on the EUR. With lots of bad news priced in there is risks in chasing the EUR lower, but the fundamental outlook remains bleak.
GBP
FUNDAMENTAL OUTLOOK: WEAK BEARISH
BASELINE
The overall bleak economic outlook for the UK, with exceptionally high Inflation and rapidly falling growth have been the biggest negative driver for Sterling. At their August meeting, the BoE confirmed this bleak outlook by forecasting the UK economy to fall into recession by 4Q22 and expects the recession to last for five quarters. Even though the bank followed through with a 50bsp hike, it wasn’t enough to offset the recession forecasts. With inflation expected to reach close to 13%, the bank is stuck between a rock and a hard place as they are forced to keep hiking rates to try and fight inflation but by doing so, they risk further damaging economic growth as a result. The post-BoE price action in Sterling did not reflect a market that was pricing in a 5-quarter recession in the UK, and the price action we saw in the past week made a lot of sense with Sterling catching up to the downside to reflect the growth situation. Headline CPI printing above 10% didn’t help the currency either, further exacerbating stagflation risks.
POSSIBLE BULLISH SURPRISES
Stagflation fears remain high for the UK, and the BoE is now projecting 5 quarters of recession starting 4Q22. With a recession now the base assumption, any incoming data that surprises meaningfully higher could trigger some relief. With focus on stagflation, any downside surprises in CPI or factors that decrease inflation pressures are expected to support the GBP and not pressure it. The economy needs help, which means any help from the fiscal side will be a positive. Any major fiscal support measures from the incoming PM to help consumers (subsidies or tax cuts) could trigger bullish reactions for the Pound. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus. For now, markets have rightly ignored this as posturing, but any major de-escalation can see some upside for Sterling.
POSSIBLE BEARISH SURPRISES
Stagflation fears remain high for the UK, and the BoE is now projecting 5 quarters of recession starting 4Q22. Even with recession now the base assumption, any material downside surprises in growth data can trigger further downside. With focus on stagflation, any upside surprises in CPI or factors that increase more inflation pressures are expected to weigh on the GBP and not support it. The economy needs help, which means any help from the fiscal side should be a positive, but any fiscal measures from the incoming PM that could exacerbate inflation pressures could trigger bearish reactions for the Pound. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus. For now, markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.
BIGGER PICTURE
The fundamental outlook for the GBP remains bleak, especially after the BoE’s recent forecasts of a 5-quarter recession in the UK. Furthermore, given the risks to growth, there is growing speculation that the BoE might not be too far away from pausing their current hiking cycle. Anything that exacerbates stagflation fears is expected to weigh on the Pound and anything that alleviates some of that pressure could see some reprieve since the currency is trading at fresh new cycle lows. Even though the bias remains bleak, there is a lot of bad news priced for Sterling, so choose your trades carefully.
FUNDAMENTAL OUTLOOK: WEAK BEARISH
BASELINE
In recent weeks, the persistently high inflation has seen the ECB take a more hawkish turn with the bank hiking rates by 50bsp at their July meeting. Additional pressure on inflation from gas supply shortages and Rhine River levels in Germany means the ECB will be forced to continue hiking rates. But the bank quelled any hawkish excitement at their July meeting by explaining they are frontloading hikes and not signalling a higher terminal rate with their bigger than expected July hike. The bank also failed to ease spread fragmentation concerns with their new Transmission Protection Instrument (TPI) as the eligibility criteria means countries like Italy and Spain that will need the support the most might have a tough time qualifying. Combined with political concerns and additional inflation pressures, further spread widening looks likely for now. Right now, even though policy and spreads are important, the main story and driver for the EUR is the economic outlook. Recent growth data continues to surprise to the downside at a rapid pace and further stoking recession fears for the Eurozone. Even though the bias remains lower, a lot of negatives have been priced in from a tactical point of view so worth keeping that in mind.
POSSIBLE BULLISH SURPRISES
De-escalation or cease fire in Ukraine would open up a lot of EUR upside. Also keep Italian politics in mind where successful attempts to avoid a snap election could ease spread widening & support the EUR. Stagflation risks remains high and recent data has invigorated recession fears, but with lots of bad news priced any materially better-than-expected growth data could spark some relief. Spread fragmentation remains a concern, especially with Italian politics and the ECB’s failed attempt to reassure markets. Any TPI comments that convinces markets it can solve fragmentation issues should be supportive for the EUR. Energy supply is also in focus, which means watching gas flows from Russia. If Russia increases gas flows to more regular levels it should ease some supply concerns and see EUR upside. Rhine river concerns are one to watch, any good news on water levels and resumption of normal transport could be a bullish catalyst for the EUR.
POSSIBLE BEARISH SURPRISES
Any escalation in the Ukraine war that risks including NATO would be big negative risks. Also keep Italian politics in mind, where any failed attempts to avoid a snap election should add further pressure on the EUR. Recent data has invigorated recession fears. Even though lots of bad news is priced, any materially worse-than-expected growth data could spark further downside some relief. Spread fragmentation remains in focus, and if the ECB fails to act when we see big jolts higher in the BTP/ Bund spread, or if any TPI comment further concern markets about its effectiveness, it could trigger bearish reactions in the EUR. Energy supply is also in focus, which means watching gas flows from Russia. If Russia decreases gas flows even further, it should increase supply concerns and see EUR downside. Rhine river concerns are one to watch, any bad news on water levels and continued breakdown in transportation could be a bearish catalyst for the EUR.
BIGGER PICTURE
The fundamental outlook remains bearish with recent leading indicators pointing to a much faster economic slowdown than markets had previously expected. The current bearish drivers (geopolitics, stagflation, spread fragmentation, energy supply concerns) far outweigh the positives from a hawkish ECB. Recession risks have opened up a narrative change for the EUR which have seen markets adjust forecasts to reflect higher recession probabilities that continues to weigh on the EUR. With lots of bad news priced in there is risks in chasing the EUR lower, but the fundamental outlook remains bleak.
GBP
FUNDAMENTAL OUTLOOK: WEAK BEARISH
BASELINE
The overall bleak economic outlook for the UK, with exceptionally high Inflation and rapidly falling growth have been the biggest negative driver for Sterling. At their August meeting, the BoE confirmed this bleak outlook by forecasting the UK economy to fall into recession by 4Q22 and expects the recession to last for five quarters. Even though the bank followed through with a 50bsp hike, it wasn’t enough to offset the recession forecasts. With inflation expected to reach close to 13%, the bank is stuck between a rock and a hard place as they are forced to keep hiking rates to try and fight inflation but by doing so, they risk further damaging economic growth as a result. The post-BoE price action in Sterling did not reflect a market that was pricing in a 5-quarter recession in the UK, and the price action we saw in the past week made a lot of sense with Sterling catching up to the downside to reflect the growth situation. Headline CPI printing above 10% didn’t help the currency either, further exacerbating stagflation risks.
POSSIBLE BULLISH SURPRISES
Stagflation fears remain high for the UK, and the BoE is now projecting 5 quarters of recession starting 4Q22. With a recession now the base assumption, any incoming data that surprises meaningfully higher could trigger some relief. With focus on stagflation, any downside surprises in CPI or factors that decrease inflation pressures are expected to support the GBP and not pressure it. The economy needs help, which means any help from the fiscal side will be a positive. Any major fiscal support measures from the incoming PM to help consumers (subsidies or tax cuts) could trigger bullish reactions for the Pound. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus. For now, markets have rightly ignored this as posturing, but any major de-escalation can see some upside for Sterling.
POSSIBLE BEARISH SURPRISES
Stagflation fears remain high for the UK, and the BoE is now projecting 5 quarters of recession starting 4Q22. Even with recession now the base assumption, any material downside surprises in growth data can trigger further downside. With focus on stagflation, any upside surprises in CPI or factors that increase more inflation pressures are expected to weigh on the GBP and not support it. The economy needs help, which means any help from the fiscal side should be a positive, but any fiscal measures from the incoming PM that could exacerbate inflation pressures could trigger bearish reactions for the Pound. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus. For now, markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.
BIGGER PICTURE
The fundamental outlook for the GBP remains bleak, especially after the BoE’s recent forecasts of a 5-quarter recession in the UK. Furthermore, given the risks to growth, there is growing speculation that the BoE might not be too far away from pausing their current hiking cycle. Anything that exacerbates stagflation fears is expected to weigh on the Pound and anything that alleviates some of that pressure could see some reprieve since the currency is trading at fresh new cycle lows. Even though the bias remains bleak, there is a lot of bad news priced for Sterling, so choose your trades carefully.