GBP
FUNDAMENTAL BIAS: BULLISH
1. The Monetary Policy outlook for the BOE
The Sep policy meeting from the BoE saw money markets rushing to price in a much faster and more aggressive policy path than previously expected. Even though this of course falls in line with our bullish bias for the Pound, we do think the market is a bit too aggressive too quick right now. The bank did explain that they now see inflation above 4% by Q4 of this year, and the possibility of more sticky inflation was the key reasons why we saw a 7-2 QE vote split with Saunders and Ramsden both dissenting to cut purchases. However, it’s important to note that the remaining 7 members still see inflation as transitory, and the fact that they expect CPI above 4% means any prints that don’t come close to that poses downside risks. Furthermore, even though the bank said their expectations of modest tightening has strengthened, the admitted that lots of uncertainties remain. A big one of these is the labour market, where even though the number of furloughed staff have decreased, that decrease has materially slowed from August which poses more uncertainty for the labour market. Thus, even though our bias remains unchanged, and we see the bank lifting rates in Q1, we do think the over optimistic moves in money markets poses short-term headwinds.
2. The country’s economic developments
The successful vaccination program that allowed the UK to open up faster and sooner than peers provided a favourable environment for Sterling and the strength of the economic recovery has meant solid growth differentials favouring GBP. However, a lot of these positives are arguably priced, and the recent slowdown in activity data that suggests peak growth has been reached could mean an uphill push for GBP to see the same size of outperformance we saw earlier. With our above comments about money markets, it also means that there is now more risk to downside surprises than was the case a few months ago. Even though the current fuel challenges should not be enough to derail the economic recovery, the NatGas shortage is much more serious and if not resolved quickly could add to some additional price pressures which in the past few sessions have seen even more aggressive pricing from money markets for additional tightening.
3. Political Developments
Even though a Brexit deal was reached at the end of last year, some issues like the Northern Ireland protocol remains, and with neither side willing to budge right now it seems like a never ending can kicking could see these issues drag on for a long time. For now, Sterling has looked through all the rigmarole and should continue to do so as long as the cans are kicked down the road.
4. CFTC Analysis
Latest CFTC data showed a positioning change of -21982 with a net non-commercial position of -20018. Sterling have seen a very impressive rebound following last week’s sell off. Right now, large speculators and leveraged funds are at odds with each other, with large speculators holding a net-short and leveraged funds still sitting on the largest net-long among the majors. Markets reacted positively to new Chief Economist Pill’s comments about inflation , which yet again sparked additional downside in SONIA futures , with money markets pricing in a 10-basis point hike in the next two months and more than 70 basis points of tightening in 2022. So, even though this amount of tightening should be positive for a currency, the reasons why the markets are pricing in the steeper rate path is out of fear of inflation and not due to a more positive economic outlook, which as we highlighted above does pose headwinds for the Pound in the weeks ahead.
USD
FUNDAMENTAL BIAS: WEAK BULLISH
1. The Monetary Policy outlook for the FED
More hawkish than expected sums up the Sep meeting. The FOMC gave the go ahead for a November tapering announcement as long as the economy develops as expected with their criteria for substantial further progress close to being met. The biggest hawkish tilt was the announcement about a faster pace of tapering, with Chair Powell saying there is broad agreement that tapering can be concluded by mid2022. Inflation projections were hawkish, with the Fed projecting Core PCE above their 2% until 2024. On labour, Chair Powell said he thought the substantial further progress threshold for employment was ‘all but met’ and explained that it won’t take a very strong September jobs print for them to start tapering as just a ‘decent’ print will do. The 2022 Dots stayed very close to the June median, but the rate path was much steeper than markets were anticipating with seven hikes expected over the forecast horizon (from just two previously). It is important here to note though that even though the path was steeper, if one compares that to a projected Core PCE >2% for 2022 to 2024, the rate path does not exactly scream fear when it comes to inflation . All in all, it was a hawkish meeting. Interestingly, it took markets about three days to realize this as the expected price action only really took hold of markets a few days later. A faster tapering was a key factor we were watching for an incrementally bullish tilt in the outlook, so market’s initial reactions were surprising. However, with the recent breakout in both US yields and the USD, this has given us more confidence in moving our fundamental outlook for the Dollar from Neutral to Weak Bullish .
2. Real Yields
With a Q4 taper start and mid-2022 taper conclusion on the card, we think further downside in real yields will be a struggle and the probability are skewed higher given the outlook for growth, inflation and policy, and higher real yields should be supportive for the USD in the med-term .
3. The global risk outlook
One supporting factor for the USD from June was the onset of downside surprises in global growth. However, recent Covid-19 case data from ourworldindata. org has shown a sharp deceleration in new cases globally. Using past occurrences as a template, the reduction in cases is likely to lead to less restrictive measures, which is likely to lead to a strong bounce in economic activity. Thus, even though we have shifted our bias to weak bullish in the med-term , the fall in cases and increased likelihood of a bounce in economic activity could mean downside for the USD from a short to intermediate time horizon (remember a re-acceleration in growth and potentially inflation = reflation)
4. Economic Data
This week we’ll finally have the September NFP print, but all the previous excitement about this event has been mitigated with the Fed’s previous meeting. The Fed’s comments that they don’t need to see a huge or stellar jobs print but that a decent print will do, has largely taken the sting out of the Sep NFP print. The current concern about inflation means that the Average Hourly Earnings release could be of more interest in market participants to see whether the current labour supply shortage sparks further acceleration in wages.
5. CFTC Analysis
Latest CFTC data showed a positioning change of +5565 with a net non-commercial position of +32026. Positioning isn’t anywhere near stress levels for the USD, but with both large speculators and leveraged funds sitting in net-long territory, it does mean that the Dollar could be more sensitive from mean reversion while still elevated after the recent push higher into new YTD highs. Thus, possible reflationary data will be a key focus point for the USD in the weeks ahead.
FUNDAMENTAL BIAS: BULLISH
1. The Monetary Policy outlook for the BOE
The Sep policy meeting from the BoE saw money markets rushing to price in a much faster and more aggressive policy path than previously expected. Even though this of course falls in line with our bullish bias for the Pound, we do think the market is a bit too aggressive too quick right now. The bank did explain that they now see inflation above 4% by Q4 of this year, and the possibility of more sticky inflation was the key reasons why we saw a 7-2 QE vote split with Saunders and Ramsden both dissenting to cut purchases. However, it’s important to note that the remaining 7 members still see inflation as transitory, and the fact that they expect CPI above 4% means any prints that don’t come close to that poses downside risks. Furthermore, even though the bank said their expectations of modest tightening has strengthened, the admitted that lots of uncertainties remain. A big one of these is the labour market, where even though the number of furloughed staff have decreased, that decrease has materially slowed from August which poses more uncertainty for the labour market. Thus, even though our bias remains unchanged, and we see the bank lifting rates in Q1, we do think the over optimistic moves in money markets poses short-term headwinds.
2. The country’s economic developments
The successful vaccination program that allowed the UK to open up faster and sooner than peers provided a favourable environment for Sterling and the strength of the economic recovery has meant solid growth differentials favouring GBP. However, a lot of these positives are arguably priced, and the recent slowdown in activity data that suggests peak growth has been reached could mean an uphill push for GBP to see the same size of outperformance we saw earlier. With our above comments about money markets, it also means that there is now more risk to downside surprises than was the case a few months ago. Even though the current fuel challenges should not be enough to derail the economic recovery, the NatGas shortage is much more serious and if not resolved quickly could add to some additional price pressures which in the past few sessions have seen even more aggressive pricing from money markets for additional tightening.
3. Political Developments
Even though a Brexit deal was reached at the end of last year, some issues like the Northern Ireland protocol remains, and with neither side willing to budge right now it seems like a never ending can kicking could see these issues drag on for a long time. For now, Sterling has looked through all the rigmarole and should continue to do so as long as the cans are kicked down the road.
4. CFTC Analysis
Latest CFTC data showed a positioning change of -21982 with a net non-commercial position of -20018. Sterling have seen a very impressive rebound following last week’s sell off. Right now, large speculators and leveraged funds are at odds with each other, with large speculators holding a net-short and leveraged funds still sitting on the largest net-long among the majors. Markets reacted positively to new Chief Economist Pill’s comments about inflation , which yet again sparked additional downside in SONIA futures , with money markets pricing in a 10-basis point hike in the next two months and more than 70 basis points of tightening in 2022. So, even though this amount of tightening should be positive for a currency, the reasons why the markets are pricing in the steeper rate path is out of fear of inflation and not due to a more positive economic outlook, which as we highlighted above does pose headwinds for the Pound in the weeks ahead.
USD
FUNDAMENTAL BIAS: WEAK BULLISH
1. The Monetary Policy outlook for the FED
More hawkish than expected sums up the Sep meeting. The FOMC gave the go ahead for a November tapering announcement as long as the economy develops as expected with their criteria for substantial further progress close to being met. The biggest hawkish tilt was the announcement about a faster pace of tapering, with Chair Powell saying there is broad agreement that tapering can be concluded by mid2022. Inflation projections were hawkish, with the Fed projecting Core PCE above their 2% until 2024. On labour, Chair Powell said he thought the substantial further progress threshold for employment was ‘all but met’ and explained that it won’t take a very strong September jobs print for them to start tapering as just a ‘decent’ print will do. The 2022 Dots stayed very close to the June median, but the rate path was much steeper than markets were anticipating with seven hikes expected over the forecast horizon (from just two previously). It is important here to note though that even though the path was steeper, if one compares that to a projected Core PCE >2% for 2022 to 2024, the rate path does not exactly scream fear when it comes to inflation . All in all, it was a hawkish meeting. Interestingly, it took markets about three days to realize this as the expected price action only really took hold of markets a few days later. A faster tapering was a key factor we were watching for an incrementally bullish tilt in the outlook, so market’s initial reactions were surprising. However, with the recent breakout in both US yields and the USD, this has given us more confidence in moving our fundamental outlook for the Dollar from Neutral to Weak Bullish .
2. Real Yields
With a Q4 taper start and mid-2022 taper conclusion on the card, we think further downside in real yields will be a struggle and the probability are skewed higher given the outlook for growth, inflation and policy, and higher real yields should be supportive for the USD in the med-term .
3. The global risk outlook
One supporting factor for the USD from June was the onset of downside surprises in global growth. However, recent Covid-19 case data from ourworldindata. org has shown a sharp deceleration in new cases globally. Using past occurrences as a template, the reduction in cases is likely to lead to less restrictive measures, which is likely to lead to a strong bounce in economic activity. Thus, even though we have shifted our bias to weak bullish in the med-term , the fall in cases and increased likelihood of a bounce in economic activity could mean downside for the USD from a short to intermediate time horizon (remember a re-acceleration in growth and potentially inflation = reflation)
4. Economic Data
This week we’ll finally have the September NFP print, but all the previous excitement about this event has been mitigated with the Fed’s previous meeting. The Fed’s comments that they don’t need to see a huge or stellar jobs print but that a decent print will do, has largely taken the sting out of the Sep NFP print. The current concern about inflation means that the Average Hourly Earnings release could be of more interest in market participants to see whether the current labour supply shortage sparks further acceleration in wages.
5. CFTC Analysis
Latest CFTC data showed a positioning change of +5565 with a net non-commercial position of +32026. Positioning isn’t anywhere near stress levels for the USD, but with both large speculators and leveraged funds sitting in net-long territory, it does mean that the Dollar could be more sensitive from mean reversion while still elevated after the recent push higher into new YTD highs. Thus, possible reflationary data will be a key focus point for the USD in the weeks ahead.