GBP
FUNDAMENTAL OUTLOOK: WEAK BEARISH
BASELINE
The negative outlook for the UK economy has been a key source of Pound weakness. Stagflation risks remain high with CPI > 10% and recession expected in 4Q22 (lasting 5 quarters). It has kept pressure on Sterling despite ongoing BoE rate hikes. However, the new PM announced a much bigger than expected fiscal plan which will keep energy prices capped for 2 years for households and will also offer support for businesses. According to some estimates, that should keep inflation capped (as the main driver has been energy), and also means that the recession could be less severe than previously thought. Thus, even though the bias for the GBP remains bearish as a recession still seems likely, the fiscal news is a positive development for Sterling on balance, and with a lot of bad news already priced in we are expecting some reprieve for Sterling with asymmetric risk to incoming data (good news expected to have a bigger upside impact compared to the impact from bad news). That also means this week’s upcoming BoE meeting will be very interesting. After the dismal economic outlook delivered in the Aug MPR and the recent policy hearings, there could be some upside risk for GBP if the bank’s verdict of the new PM’s fiscal plan means lower price pressures and a less severe recession outlook.
POSSIBLE BULLISH SURPRISES
With recession the base assumption, any incoming data that surprises meaningfully higher could trigger relief for the GBP. 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 fiscal announcements last week were a welcome change, and any further support measures announced by the new PM should continue to ease stagflation fears. Given STIR pricing, a 50bsp could trigger initial GBP downside, but we could see upside if the bank sounds slightly more optimistic about the economy with the proposed fiscal plan.
POSSIBLE BEARISH SURPRISES
With recession the base assumption, any material downside surprises in growth data can still trigger short-term pressure. 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 fiscal announcements last week were a welcome change, and any potential walk back from the new PM on the plans laid out last week would increase stagflation fears once again. Given STIR pricing, a 50bsp could trigger initial downside, but we could see further downside if the bank explains the medterm debt risk of the new fiscal plan outweighs the benefits.
BIGGER PICTURE
The fundamentals for Sterling remain bearish, 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 pressure could see some reprieve. Since Sterling is trading at fresh new cycle lows, the risk to reward for chasing it lower looks unattractive, and we could see asymmetric reactions skewed to the upside on positive data & news. Furthermore, we think the new PM’s proposed fiscal plan has not received the bullish attention it deserves. What the BoE have to say about the proposed fiscal spending and how it’s likely to impact growth and inflation will be important this week.
USD
FUNDAMENTAL OUTLOOK: BULLISH
BASELINE
With headline CPI above 8%, the Fed is under pressure to continue hiking rates and ramping up QT to try and equalize supply and demand. They hiked rates 75bsp in July, and after the strong Aug CPI, another 75bsp hike is fully priced and question for the FOMC meeting this week is whether they hike 100bsp. Recent Fed communication pushed back against rate cuts in 2023 and stressed that rates could reach close to 4% in early 2023 and stay there throughout 2023. In July, the Fed announced a data-dependent (meeting-by-meeting) policy stance, explaining that the pace of hikes is likely to slow as rates get more restrictive and more data becomes available. This means incoming growth, inflation and jobs data remains key drivers for short-term USD price action where we expect a cyclical reaction to incoming data (good data being good for the USD and US10Y and bad data being bad for the USD and US10Y). The Aug CPI print saw markets pricing out the likelihood of a soft landing. This saw further downside in bonds and equities and upside in the USD. However, this narrative is still in focus for many market participants. So, if incoming data continues to suggest that a soft landing is possible, we expect that to pressure the USD. But we’ll let the data guide us.
POSSIBLE BULLISH SURPRISES
With the Fed signalling a data dependent policy stance, we expect a cyclical reaction from the USD with incoming US data. Thus, extremely good growth, inflation or jobs data is expected to trigger short-term bullish reactions in the USD. If the cyclical outlook continues to weaken, the USD’s safe haven status still matters. Any incoming data that exacerbates fears of a deep recession and triggers strong moves lower in risk assets & bonds can trigger safe haven flows into the USD. The Aug CPI saw markets price in a higher terminal rate for the current Fed cycle, which means a lot is already priced going into the FOMC decision. However, should the Fed bring out the big guns and the Dot Plot median for 2023 is closer to 5% or they hike 100bsp, that could trigger further USD upside.
POSSIBLE BEARISH SURPRISES
With the Fed signalling a data dependent policy stance, we expect a cyclical reaction from the USD with incoming US data. Thus, extremely bad growth, inflation or jobs data is expected to trigger short-term bearish reactions in the USD. With some growing expectations of a possible ‘soft landing’ for the US economy surfacing, further goldilocks data (higher growth & labour but lower inflation) could trigger safe haven outflows from the USD and into US equities. With a lot priced in for the Fed and the USD, it won’t take much to disappoint on the dovish side this week with their FOMC decision. If the dot plot does not exceed what is already priced for the curve or the Fed sticks to a 75bsp hike, it could trigger some sell-the-fact reactions to the downside for the USD.
BIGGER PICTURE
The fundamental outlook for the USD remains bullish as long as the Fed stays hawkish and cyclical concerns put pressure on risk assets. But the data dependent stance from the Fed means that short-term data surprises can pull the USD either way. The recent string of data has triggered some ‘soft landing’ expectations for the US economy, which is expected to weigh on the USD given all of the safe haven inflows based on recession fears. This makes incoming data even more important. Going into the FOMC, there is already a lot priced for the on the rate side and markets are preparing for a very hawkish message. That does increase the risk of a sell-the-fact reaction.
FUNDAMENTAL OUTLOOK: WEAK BEARISH
BASELINE
The negative outlook for the UK economy has been a key source of Pound weakness. Stagflation risks remain high with CPI > 10% and recession expected in 4Q22 (lasting 5 quarters). It has kept pressure on Sterling despite ongoing BoE rate hikes. However, the new PM announced a much bigger than expected fiscal plan which will keep energy prices capped for 2 years for households and will also offer support for businesses. According to some estimates, that should keep inflation capped (as the main driver has been energy), and also means that the recession could be less severe than previously thought. Thus, even though the bias for the GBP remains bearish as a recession still seems likely, the fiscal news is a positive development for Sterling on balance, and with a lot of bad news already priced in we are expecting some reprieve for Sterling with asymmetric risk to incoming data (good news expected to have a bigger upside impact compared to the impact from bad news). That also means this week’s upcoming BoE meeting will be very interesting. After the dismal economic outlook delivered in the Aug MPR and the recent policy hearings, there could be some upside risk for GBP if the bank’s verdict of the new PM’s fiscal plan means lower price pressures and a less severe recession outlook.
POSSIBLE BULLISH SURPRISES
With recession the base assumption, any incoming data that surprises meaningfully higher could trigger relief for the GBP. 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 fiscal announcements last week were a welcome change, and any further support measures announced by the new PM should continue to ease stagflation fears. Given STIR pricing, a 50bsp could trigger initial GBP downside, but we could see upside if the bank sounds slightly more optimistic about the economy with the proposed fiscal plan.
POSSIBLE BEARISH SURPRISES
With recession the base assumption, any material downside surprises in growth data can still trigger short-term pressure. 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 fiscal announcements last week were a welcome change, and any potential walk back from the new PM on the plans laid out last week would increase stagflation fears once again. Given STIR pricing, a 50bsp could trigger initial downside, but we could see further downside if the bank explains the medterm debt risk of the new fiscal plan outweighs the benefits.
BIGGER PICTURE
The fundamentals for Sterling remain bearish, 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 pressure could see some reprieve. Since Sterling is trading at fresh new cycle lows, the risk to reward for chasing it lower looks unattractive, and we could see asymmetric reactions skewed to the upside on positive data & news. Furthermore, we think the new PM’s proposed fiscal plan has not received the bullish attention it deserves. What the BoE have to say about the proposed fiscal spending and how it’s likely to impact growth and inflation will be important this week.
USD
FUNDAMENTAL OUTLOOK: BULLISH
BASELINE
With headline CPI above 8%, the Fed is under pressure to continue hiking rates and ramping up QT to try and equalize supply and demand. They hiked rates 75bsp in July, and after the strong Aug CPI, another 75bsp hike is fully priced and question for the FOMC meeting this week is whether they hike 100bsp. Recent Fed communication pushed back against rate cuts in 2023 and stressed that rates could reach close to 4% in early 2023 and stay there throughout 2023. In July, the Fed announced a data-dependent (meeting-by-meeting) policy stance, explaining that the pace of hikes is likely to slow as rates get more restrictive and more data becomes available. This means incoming growth, inflation and jobs data remains key drivers for short-term USD price action where we expect a cyclical reaction to incoming data (good data being good for the USD and US10Y and bad data being bad for the USD and US10Y). The Aug CPI print saw markets pricing out the likelihood of a soft landing. This saw further downside in bonds and equities and upside in the USD. However, this narrative is still in focus for many market participants. So, if incoming data continues to suggest that a soft landing is possible, we expect that to pressure the USD. But we’ll let the data guide us.
POSSIBLE BULLISH SURPRISES
With the Fed signalling a data dependent policy stance, we expect a cyclical reaction from the USD with incoming US data. Thus, extremely good growth, inflation or jobs data is expected to trigger short-term bullish reactions in the USD. If the cyclical outlook continues to weaken, the USD’s safe haven status still matters. Any incoming data that exacerbates fears of a deep recession and triggers strong moves lower in risk assets & bonds can trigger safe haven flows into the USD. The Aug CPI saw markets price in a higher terminal rate for the current Fed cycle, which means a lot is already priced going into the FOMC decision. However, should the Fed bring out the big guns and the Dot Plot median for 2023 is closer to 5% or they hike 100bsp, that could trigger further USD upside.
POSSIBLE BEARISH SURPRISES
With the Fed signalling a data dependent policy stance, we expect a cyclical reaction from the USD with incoming US data. Thus, extremely bad growth, inflation or jobs data is expected to trigger short-term bearish reactions in the USD. With some growing expectations of a possible ‘soft landing’ for the US economy surfacing, further goldilocks data (higher growth & labour but lower inflation) could trigger safe haven outflows from the USD and into US equities. With a lot priced in for the Fed and the USD, it won’t take much to disappoint on the dovish side this week with their FOMC decision. If the dot plot does not exceed what is already priced for the curve or the Fed sticks to a 75bsp hike, it could trigger some sell-the-fact reactions to the downside for the USD.
BIGGER PICTURE
The fundamental outlook for the USD remains bullish as long as the Fed stays hawkish and cyclical concerns put pressure on risk assets. But the data dependent stance from the Fed means that short-term data surprises can pull the USD either way. The recent string of data has triggered some ‘soft landing’ expectations for the US economy, which is expected to weigh on the USD given all of the safe haven inflows based on recession fears. This makes incoming data even more important. Going into the FOMC, there is already a lot priced for the on the rate side and markets are preparing for a very hawkish message. That does increase the risk of a sell-the-fact reaction.