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. But the bank quelled any hawkish excitement by explaining they are frontloading hikes and not signalling a higher terminal rate with their bigger than expected July hike. At their July meeting the bank also failed to ease spread fragmentation concerns with their new Transmission Protection Instrument (TPI) as the eligibility criteria means countries that will need the support the most might have a tough time qualifying. Combined with Italian political concerns, further spread widening looks likely. 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 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 though.
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 remain 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 concerns are still in focus, which means watching the Nord Stream 1 flows, if Russia increases gas flows to more regular levels it should ease some energy supply issues. 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. Growth concerns continue to weigh on the EUR and means any major negative surprises in incoming growth data (German ZEW data next week) could trigger downside in the EUR. Spread fragmentation remains in focus, and if the ECB fails to act when we see big jolts higher in the BTP/ Bund spread it could trigger bearish reactions in the EUR. Energy concerns are still in focus, which means watching the Nord Stream 1 flows, if Russia decreases gas flows again it should increase concerns and weigh on the EUR. 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 open up a narrative change for the EUR which will require markets to adjust forecasts to reflect higher recession probabilities which should weigh on the EUR. Having said that, with lots of bad news priced there is some asymmetric risk to incoming data which means chasing at the lows are dangerous.
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. Even though Sterling is still fairly close to recent lows (at the index level), the recent bounce was enough to short into, and we saw sizeable downside following the BoE decision. It seems unlikely that the post-BoE price action reflects a market that has already priced in a 5-quarter recession, so we expect sentiment to remain bearish on Sterling for now.
POSSIBLE BULLISH SURPRISES
Stagflation fears are very high for the UK, with probabilities of recession growing by the week. With a recession now the base assumption, any incoming news that surprises meaningfully higher could trigger some relief. The UK is facing a huge cost-of-living squeeze, which means lower-than-expected inflation could counterintuitively be a positive driver (as lower CPI means less stagflation risk). The economy needs help right now, which means any help from the fiscal side will be a positive. Any major fiscal support measures to help consumers (subsidies for energy or tax cuts) could trigger bullish reactions for the Pound. Any overly hawkish fiscal promises from PM candidates which eases recession fears could be a positive trigger for Sterling. Any overly hawkish comments signalling more aggressive policy than what markets are currently pricing in could trigger bullish reactions.
POSSIBLE BEARISH SURPRISES
Odds that the BoE has limited hikes left has been a negative driver, but so too is risks that inflation forces them to hike even more and further damage GDP. Further stagflation risks from higher gas prices or CPI could trigger bearish reactions. Politicsremain a focus, where any attempts by a new PM in the weeks or months ahead to call for a snap election should cause unnecessary uncertainty and could trigger GBP downside. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus again. For now, markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside. Any overly dovish fiscal promises from PM candidates that increase recession fears could be a negative trigger for Sterling Any overly dovish comments signalling less aggressive policy than what markets are currently pricing in could trigger bearish GBP reactions.
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. Anything that exacerbates stagflation fears is expected to weigh on the Pound and anything that alleviates some of that pressure should be positive. The post-BoE price action was big, but not big enough for a market that has priced in a deep recession, which means we would expect sentiment to remain soft on Sterling after the most recent BoE meeting, but incoming data this week could trigger short-term sentiment reactions as always.
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. But the bank quelled any hawkish excitement by explaining they are frontloading hikes and not signalling a higher terminal rate with their bigger than expected July hike. At their July meeting the bank also failed to ease spread fragmentation concerns with their new Transmission Protection Instrument (TPI) as the eligibility criteria means countries that will need the support the most might have a tough time qualifying. Combined with Italian political concerns, further spread widening looks likely. 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 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 though.
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 remain 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 concerns are still in focus, which means watching the Nord Stream 1 flows, if Russia increases gas flows to more regular levels it should ease some energy supply issues. 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. Growth concerns continue to weigh on the EUR and means any major negative surprises in incoming growth data (German ZEW data next week) could trigger downside in the EUR. Spread fragmentation remains in focus, and if the ECB fails to act when we see big jolts higher in the BTP/ Bund spread it could trigger bearish reactions in the EUR. Energy concerns are still in focus, which means watching the Nord Stream 1 flows, if Russia decreases gas flows again it should increase concerns and weigh on the EUR. 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 open up a narrative change for the EUR which will require markets to adjust forecasts to reflect higher recession probabilities which should weigh on the EUR. Having said that, with lots of bad news priced there is some asymmetric risk to incoming data which means chasing at the lows are dangerous.
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. Even though Sterling is still fairly close to recent lows (at the index level), the recent bounce was enough to short into, and we saw sizeable downside following the BoE decision. It seems unlikely that the post-BoE price action reflects a market that has already priced in a 5-quarter recession, so we expect sentiment to remain bearish on Sterling for now.
POSSIBLE BULLISH SURPRISES
Stagflation fears are very high for the UK, with probabilities of recession growing by the week. With a recession now the base assumption, any incoming news that surprises meaningfully higher could trigger some relief. The UK is facing a huge cost-of-living squeeze, which means lower-than-expected inflation could counterintuitively be a positive driver (as lower CPI means less stagflation risk). The economy needs help right now, which means any help from the fiscal side will be a positive. Any major fiscal support measures to help consumers (subsidies for energy or tax cuts) could trigger bullish reactions for the Pound. Any overly hawkish fiscal promises from PM candidates which eases recession fears could be a positive trigger for Sterling. Any overly hawkish comments signalling more aggressive policy than what markets are currently pricing in could trigger bullish reactions.
POSSIBLE BEARISH SURPRISES
Odds that the BoE has limited hikes left has been a negative driver, but so too is risks that inflation forces them to hike even more and further damage GDP. Further stagflation risks from higher gas prices or CPI could trigger bearish reactions. Politicsremain a focus, where any attempts by a new PM in the weeks or months ahead to call for a snap election should cause unnecessary uncertainty and could trigger GBP downside. With UK threats of triggering Article 16 and EU threats to terminate the Brexit deal if they do Brexit is in focus again. For now, markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside. Any overly dovish fiscal promises from PM candidates that increase recession fears could be a negative trigger for Sterling Any overly dovish comments signalling less aggressive policy than what markets are currently pricing in could trigger bearish GBP reactions.
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. Anything that exacerbates stagflation fears is expected to weigh on the Pound and anything that alleviates some of that pressure should be positive. The post-BoE price action was big, but not big enough for a market that has priced in a deep recession, which means we would expect sentiment to remain soft on Sterling after the most recent BoE meeting, but incoming data this week could trigger short-term sentiment reactions as always.