EUR
FUNDAMENTAL OUTLOOK: WEAK BEARISH
BASELINE
Persistently high inflation has seen the ECB tilt more hawkish by hiking rates 50bsp in July. Additional pressure on inflation from gas supply shortages and drought-linked supply constraints has seen ECB members get more uneasy about price pressures, with comments last week suggesting that there is growing support for a 75bsp hike in September. This saw some initial upside in the EUR, but it’s important to remember that the bank quelled hawkish excitement at the July meeting by saying that frontloading hikes are not a signal of a higher terminal rate. Until that changes, higher rate expectations are likely only going to have short-lived upside potential for the Euro. Spread fragmentation, even though largely moving into the background, is still a concern, with the ECB failing to ease the market’s spread 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. Even though policy is important, the main driver for the EUR is the economic outlook. Recent growth data has continued to flag recession risks and as energy concerns increase so too does the likelihood of stagflation. 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. Stagflation risks remains, but with lots of bad news priced any materially better-than-expected data could spark some relief. Spread fragmentation remains a concern, thus, any TPI comments that convinces markets it can solve fragmentation issues should be supportive for the EUR. Energy supply is a problem. If Russia does re-opens gas flows after the planned shutdown it should ease some pressure. Any good news on Rhine 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. Stagflation risks remains, even with lots of bad news priced any materially worse-than-expected data could see more pressure. Spread fragmentation remains in focus, and if the ECB fails to act when we see big jolts higher in the BTP/Bund spread could trigger bearish reactions in the EUR. Energy supply is a problem. If Russia does not re-open gas flows after the planned shutdown it should add downside risks. Any bad news on Rhine 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 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 which has continued 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 outlook for the UK economy remains bleak, with CPI above 10% and recession expecting to hit in 4Q22 and last for 5 quarters, it has kept pressure on Sterling despite ongoing BoE rate hikes. Even though the bank followed through with a 50bsp hike in July, it wasn’t enough to offset the recession forecasts. With inflation expected to reach close to 13%, and some participants calling for as high as 18% by next year (due to the rapid rise in energy prices) 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 two weeks made a lot of sense with Sterling catching up to the downside to reflect the growth situation. Even though the bias remains titled lower, a lot of bad news has once again been priced in for the Pound in a relatively short space of time, and with positioning continuing to give bullish signals, chasing lower seems like a bit of a risk right now.
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
Persistently high inflation has seen the ECB tilt more hawkish by hiking rates 50bsp in July. Additional pressure on inflation from gas supply shortages and drought-linked supply constraints has seen ECB members get more uneasy about price pressures, with comments last week suggesting that there is growing support for a 75bsp hike in September. This saw some initial upside in the EUR, but it’s important to remember that the bank quelled hawkish excitement at the July meeting by saying that frontloading hikes are not a signal of a higher terminal rate. Until that changes, higher rate expectations are likely only going to have short-lived upside potential for the Euro. Spread fragmentation, even though largely moving into the background, is still a concern, with the ECB failing to ease the market’s spread 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. Even though policy is important, the main driver for the EUR is the economic outlook. Recent growth data has continued to flag recession risks and as energy concerns increase so too does the likelihood of stagflation. 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. Stagflation risks remains, but with lots of bad news priced any materially better-than-expected data could spark some relief. Spread fragmentation remains a concern, thus, any TPI comments that convinces markets it can solve fragmentation issues should be supportive for the EUR. Energy supply is a problem. If Russia does re-opens gas flows after the planned shutdown it should ease some pressure. Any good news on Rhine 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. Stagflation risks remains, even with lots of bad news priced any materially worse-than-expected data could see more pressure. Spread fragmentation remains in focus, and if the ECB fails to act when we see big jolts higher in the BTP/Bund spread could trigger bearish reactions in the EUR. Energy supply is a problem. If Russia does not re-open gas flows after the planned shutdown it should add downside risks. Any bad news on Rhine 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 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 which has continued 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 outlook for the UK economy remains bleak, with CPI above 10% and recession expecting to hit in 4Q22 and last for 5 quarters, it has kept pressure on Sterling despite ongoing BoE rate hikes. Even though the bank followed through with a 50bsp hike in July, it wasn’t enough to offset the recession forecasts. With inflation expected to reach close to 13%, and some participants calling for as high as 18% by next year (due to the rapid rise in energy prices) 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 two weeks made a lot of sense with Sterling catching up to the downside to reflect the growth situation. Even though the bias remains titled lower, a lot of bad news has once again been priced in for the Pound in a relatively short space of time, and with positioning continuing to give bullish signals, chasing lower seems like a bit of a risk right now.
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.