GBP
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
BoE credibility took a hit in Nov when the bank voted 7-2 to keep rates on hold and took a clear U-turn compared to hawkish comments from the likes of Bailey and Pill. Going into the meeting markets had fully priced a 15bsp hike in 4Q21, and even though analysts were divided on whether that hike would be in Nov or Dec, the bank’s statement and tone saw markets pushed back hike bets. This came as a result of the bank’s dovish tilt regarding GDP, CPI as well as a change of tone which said hikes would only be appropriate in the coming months if the labour data comes in line with the bank’s projections. We were anticipating a violent repricing for med-term rate expectations stressing that rates markets were too aggressively priced, but the U-turn in tone surprising
and placed lots of focus on incoming labour & CPI data to gauge when lift off will occur. The bank pushed back against attacks on their credibility and said they won’t endorse market rate pricing. Overall, it was a dovish tone, and the hit to credibility means markets will be more careful with jumping the gun on their forward guidance going forward. As the bank bases their economic projections on a market implied bank rate, there is chances that things like GBP and CPI see upward revisions if the med-term market expectations for higher hikes trade a bit more realistic.
2. Economic & Health Developments
Even though activity data has been slowing, the economy is not expected to fall off a cliff by any means. Furthermore, the very solid beats across the board in recent economic data have for many solidified the odds of a 15bsp hike in Dec. It was interesting to note that both BoE’s Pill and Bailey, even after the solid data, offered some slightly sobering remarks last week which some took as a sign that a Dec hike is not a guaranteed decision just yet. Of course, the Oct jobs print in December will be very important for markets as another beat there will leave the BoE with very few reasons not to hike rates. Interestingly, not even the more optimistic comments from the likes of Haskel (dove) was enough to drag the GBP out of its slumber.
3. Political Developments
Even though a Brexit deal was reached last year, some issues like the Northern Ireland protocol remains, and with neither side willing to budge it seems like these issues are here to stay for now. There has been heated rhetoric from both sides with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, these are just threats, but any actual escalation could increase the odds of seeing so risk premium built into Sterling. Also keep the fishing challenges with France in mind as well.
4. CFTC Analysis
Latest CFTC data showed a positioning change of -4320 with a net non-commercial position of -38899. Sterling is now the third largest net-short among the majors and also dipped into net-short among leveraged funds as well. That shows us sentiment continues to deteriorate for the GBP after the Nov 4 policy meeting, and that is despite recent economic data coming in much better-than-expected.
5. The Week Ahead
Patience will be very important for the week ahead when it comes to the GBP. Friday’s comments from BoE’s Saunders were quite surprising, with the most hawkish member on the MPC sounding strangely dovish on the eve of the Dec policy meeting. Saunders explained that the Omicron variant could mean that there is scope to wait for more data before adjusting policy, if adjusting policy is necessary (that doesn’t sound like a hawk ready to vote for hiking rates in a few days’ time). Interestingly we’ve seen some of the more dovish members among the MPC take a slightly more optimistic and hawkish turn with Haskel giving a green light for rates to move higher in we see another solid job print next week. Thus, for now, until we get the job data, it might be best to
keep Sterling on the side lines for now.
USD
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
Another bank that was hawkish in deed by dovish in word in their Nov policy decision. The Fed announced tapering as expected, with purchases to be reduced at a pace of $10bln in Treasuries and $5bln in MBS per month and explained that a mid-2022 conclusion is their base case. There were also some hawkish language changes about inflation , with the bank dropping previous comments that called inflation transitory and replacing it with ‘expected to be transitory’, basically leaving some optionality to pivot more aggressively with tapering should price pressures stay sticky for too long. However, Fed Chair Powell did a really good job to put on a familiar dovish front by explaining that they see the current price pressures as driven by supply bottlenecks and still see those pressures cooling down in in 1H22, essentially giving themselves half a year of ‘tolerating’ the current inflation overshoot. Apart from that, Chair Powell explained that they would need to see maximum employment before their conditions for a lift off in rates would be met, and also explained that it’s likely that full employment could be reached by mid-2022. That endorsed the idea that a 2h22 hike is possible, but the Chair refused to provide any idea of what maximum employment would look like. On the rate front, Powell also explained that they think they can be patient with rates right now as they want more time to see in what shape the economy is in after the current covid shocks have calmed and after bottlenecks have eased. Overall, a policy meeting that was hawkish in their actions but dovish in their words.
2. Real Yields
With a Q4 taper start and a faster 2022 taper on the table, further material downside in real yields looks like a struggle, and upside from here should be supportive for the USD. However, we are growing cautious of nominal yields right now as an aggressive Fed is not a positive for US10Y . But it also means there are risks that inflation expectations fall and place upside pressure on real yields.
3. Global Risk Outlook
Based on the recent global economic data the expectations of a possible reflationary setup have developed as the Citi Economic Surprise Index continues to push higher. Even though this was seen as a possible negative for the USD, the recent hawkish tilt from the Fed (accompanied by the Omicron variant) has seen drastic curve flattening in anticipation that the Fed might be on its way to a policy mistake, and we could see a possible repeat scenario like we had back in 4Q18. If that happens, it should be an additional tailwind for the USD, which means for now a lot of hinges on the new variant.
4. CFTC Analysis
Latest CFTC data showed a positioning change of +104 with a net non-commercial position of +35879. USD longs are looking stretched, and arguably have been looking stretched for the past few weeks. With large speculators at their highest level since 2019, there is some scope for some mean reversion lower in the USD. It’s also important to remember that a lot of the Fed hawkishness should now be reflected in the price. The biggest risk to upside is if the med-term growth and inflation outlook materially deteriorate from here.
5. The Week Ahead
With Fed Chair Powell already giving the markets the prewarning of a faster tapering decision next week, there isn’t much that will change that with this week’s line up of economic data. The biggest even will no doubt be the CPI print on Friday, where markets are expecting a new cycle high for consumer prices. With so many expectations baked in for the Fed and with so many higher inflation projections doing the rounds, the highest tradable event for the USD this week would be a huge surprise miss as that will catch everyone by surprise and offer some decent downside in the short-term for the USD. Even though a beat in the CPI data should see
further expectations of tighter policy, markets are so close to pricing in 3 hikes for next year again which means the upside on a beat might be more limited compared to the Nov CPI print.
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
BoE credibility took a hit in Nov when the bank voted 7-2 to keep rates on hold and took a clear U-turn compared to hawkish comments from the likes of Bailey and Pill. Going into the meeting markets had fully priced a 15bsp hike in 4Q21, and even though analysts were divided on whether that hike would be in Nov or Dec, the bank’s statement and tone saw markets pushed back hike bets. This came as a result of the bank’s dovish tilt regarding GDP, CPI as well as a change of tone which said hikes would only be appropriate in the coming months if the labour data comes in line with the bank’s projections. We were anticipating a violent repricing for med-term rate expectations stressing that rates markets were too aggressively priced, but the U-turn in tone surprising
and placed lots of focus on incoming labour & CPI data to gauge when lift off will occur. The bank pushed back against attacks on their credibility and said they won’t endorse market rate pricing. Overall, it was a dovish tone, and the hit to credibility means markets will be more careful with jumping the gun on their forward guidance going forward. As the bank bases their economic projections on a market implied bank rate, there is chances that things like GBP and CPI see upward revisions if the med-term market expectations for higher hikes trade a bit more realistic.
2. Economic & Health Developments
Even though activity data has been slowing, the economy is not expected to fall off a cliff by any means. Furthermore, the very solid beats across the board in recent economic data have for many solidified the odds of a 15bsp hike in Dec. It was interesting to note that both BoE’s Pill and Bailey, even after the solid data, offered some slightly sobering remarks last week which some took as a sign that a Dec hike is not a guaranteed decision just yet. Of course, the Oct jobs print in December will be very important for markets as another beat there will leave the BoE with very few reasons not to hike rates. Interestingly, not even the more optimistic comments from the likes of Haskel (dove) was enough to drag the GBP out of its slumber.
3. Political Developments
Even though a Brexit deal was reached last year, some issues like the Northern Ireland protocol remains, and with neither side willing to budge it seems like these issues are here to stay for now. There has been heated rhetoric from both sides with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, these are just threats, but any actual escalation could increase the odds of seeing so risk premium built into Sterling. Also keep the fishing challenges with France in mind as well.
4. CFTC Analysis
Latest CFTC data showed a positioning change of -4320 with a net non-commercial position of -38899. Sterling is now the third largest net-short among the majors and also dipped into net-short among leveraged funds as well. That shows us sentiment continues to deteriorate for the GBP after the Nov 4 policy meeting, and that is despite recent economic data coming in much better-than-expected.
5. The Week Ahead
Patience will be very important for the week ahead when it comes to the GBP. Friday’s comments from BoE’s Saunders were quite surprising, with the most hawkish member on the MPC sounding strangely dovish on the eve of the Dec policy meeting. Saunders explained that the Omicron variant could mean that there is scope to wait for more data before adjusting policy, if adjusting policy is necessary (that doesn’t sound like a hawk ready to vote for hiking rates in a few days’ time). Interestingly we’ve seen some of the more dovish members among the MPC take a slightly more optimistic and hawkish turn with Haskel giving a green light for rates to move higher in we see another solid job print next week. Thus, for now, until we get the job data, it might be best to
keep Sterling on the side lines for now.
USD
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
Another bank that was hawkish in deed by dovish in word in their Nov policy decision. The Fed announced tapering as expected, with purchases to be reduced at a pace of $10bln in Treasuries and $5bln in MBS per month and explained that a mid-2022 conclusion is their base case. There were also some hawkish language changes about inflation , with the bank dropping previous comments that called inflation transitory and replacing it with ‘expected to be transitory’, basically leaving some optionality to pivot more aggressively with tapering should price pressures stay sticky for too long. However, Fed Chair Powell did a really good job to put on a familiar dovish front by explaining that they see the current price pressures as driven by supply bottlenecks and still see those pressures cooling down in in 1H22, essentially giving themselves half a year of ‘tolerating’ the current inflation overshoot. Apart from that, Chair Powell explained that they would need to see maximum employment before their conditions for a lift off in rates would be met, and also explained that it’s likely that full employment could be reached by mid-2022. That endorsed the idea that a 2h22 hike is possible, but the Chair refused to provide any idea of what maximum employment would look like. On the rate front, Powell also explained that they think they can be patient with rates right now as they want more time to see in what shape the economy is in after the current covid shocks have calmed and after bottlenecks have eased. Overall, a policy meeting that was hawkish in their actions but dovish in their words.
2. Real Yields
With a Q4 taper start and a faster 2022 taper on the table, further material downside in real yields looks like a struggle, and upside from here should be supportive for the USD. However, we are growing cautious of nominal yields right now as an aggressive Fed is not a positive for US10Y . But it also means there are risks that inflation expectations fall and place upside pressure on real yields.
3. Global Risk Outlook
Based on the recent global economic data the expectations of a possible reflationary setup have developed as the Citi Economic Surprise Index continues to push higher. Even though this was seen as a possible negative for the USD, the recent hawkish tilt from the Fed (accompanied by the Omicron variant) has seen drastic curve flattening in anticipation that the Fed might be on its way to a policy mistake, and we could see a possible repeat scenario like we had back in 4Q18. If that happens, it should be an additional tailwind for the USD, which means for now a lot of hinges on the new variant.
4. CFTC Analysis
Latest CFTC data showed a positioning change of +104 with a net non-commercial position of +35879. USD longs are looking stretched, and arguably have been looking stretched for the past few weeks. With large speculators at their highest level since 2019, there is some scope for some mean reversion lower in the USD. It’s also important to remember that a lot of the Fed hawkishness should now be reflected in the price. The biggest risk to upside is if the med-term growth and inflation outlook materially deteriorate from here.
5. The Week Ahead
With Fed Chair Powell already giving the markets the prewarning of a faster tapering decision next week, there isn’t much that will change that with this week’s line up of economic data. The biggest even will no doubt be the CPI print on Friday, where markets are expecting a new cycle high for consumer prices. With so many expectations baked in for the Fed and with so many higher inflation projections doing the rounds, the highest tradable event for the USD this week would be a huge surprise miss as that will catch everyone by surprise and offer some decent downside in the short-term for the USD. Even though a beat in the CPI data should see
further expectations of tighter policy, markets are so close to pricing in 3 hikes for next year again which means the upside on a beat might be more limited compared to the Nov CPI print.