GBP
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
Hawkish surprise with a hint of dovish undertones sums up the Feb BoE decision. The bank announced the start of passive QT and also hiked rates by 25bsp as expected, but the vote split was unanimous (9-0) but with a big hawkish surprise being 4 MPC members voting for a 50bsp hike. Inflation forecasts saw a big upward revision to a 7.25% peak by April ( prev . 6.0%) & 5.21% in 1-year ( prev . 3.40%). This initial hawkish statement saw immediate strength for GBP but during the press conference the BoE tried their best to get a dovish landing. Gov Bailey started his opening remarks by noting that the MPC’s decision to hike was not because the economy was strong but only because higher rates were necessary to return inflation to target, and even though he opened the door for further hikes he added that markets should not assume rates are on a long march higher. He also acknowledged the stagflation fears recently voiced by some market participants by saying that policy faces a trade off between weakening growth and higher inflation . Despite the dovish nuances, STIR markets still price an implied cash rate of 1.0% by May which would mean a 25bsp in both March and May (1.0% is the level the BoE previously said they would being outright Gilt selling). Overall, the statement was hawkish, but
the clear dovish undertones from the BoE was a bit surprising and also a bit worrisome for the future outlook.
2. Economic & Health Developments
There is a growing chorus of participants calling for a very tough road ahead for UK growth, and most recent Retail Sales data gave more confirmation to this expectation. Forecasts by the IMF/OECB still sees decent growth differentials, but not everyone shares that optimism (Refinitiv polling data). Even though the solid econ data going into Dec was enough to see the BoE hike, the overall rate expectations already priced in by markets are too ambitious. As long incoming data stay solid it should keep odds for additional tightening alive, but we should be mindful of repricing if the incoming data starts confirming a bleaker picture for growth.
3. Political Developments
The political uncertainty surrounding PM Johnson mean a higher risk premium for GBP. The fallout from the heavily redacted Sue Gray report was limited but reports over the weekend show a growing distrust for the PM from within his own party. The question remains whether enough MPs opt for a vote of no-confidence (if so, that could see short-term downside), but after that the focus will be on whether the PM can survive an actual vote of no-confidence, where a win is expected to be GBP positive and negative for Sterling if he loses. The North Ireland protocol is still in focus in the background with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, markets have rightly ignored this as political posturing, but of course any actual escalation could see sharp risk premium built into the GBP
4. CFTC Analysis
The CFTC data for GBP was very surprising. Recall that the downside in the GBP only started later during last week, which means that the very big increase in net-short positioning occurred while Sterling was still flying high. The question here is whether this was some political risk premiums building up or part of a bigger change in sentiment as concerns over the UK’s growth outlook continues to surface.
5. The Week Ahead
Just like the EUR, the biggest focus for the week ahead for Sterling will be on BoE talk. The bank tried really hard to get a dovish landing on Thursday, and any additional info and clarity from them will be keenly watched by market participants. With STIR markets pricing in an implied rate of 1.0% by May, one would have thought more upside is warranted for Sterling, but after the dovish undertones as well as the ongoing political challenges things are looking a bit messy for the GBP right now. If we see a similar divergence between ECB and BoE language like we saw at the press conferences that should put further upside pressure on EURGBP.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Jan FOMC decision was hawkish on multiple fronts. The statement signalled a March hike as expected, but Chair Powell portrayed a very hawkish tone. Even though Powell said they can’t predict the rate path with certainty, he stressed the economy is in much better shape compared to the 2015 cycle and that will have implications for the pace of hikes (more and faster). Furthermore, he explained that there is ‘quite a bit of room’ to raise rates without damaging employment, which suggests upside risks to the rate path. A big question going into the meeting was how concerned the Fed was about recent equity market volatility . But the Chair explained that markets and financial conditions are reflecting policy changes in advance and that in aggregate the measures they look at isn’t showing red lights. Thus, any ‘Fed Put’ is much further away and inflation is the Fed’s biggest concern right now. The Chair also didn’t rule out the possibility of a 50bsp hike in March or possibly hiking at every meeting this year, which was hawkish as it means the Fed wants optionality to move more aggressive if they need to. We didn’t get new info on the balance sheet and Powell reiterated that they’re contemplating a start of QT after hiking has begun and they’ll discuss this in coming meetings. Overall, the tone and language was lot more hawkish than the Dec meeting and more hawkish than consensus was expecting.
2. Global & Domestic Economy
As the reserve currency, the USD’s global usage means it’s usually inversely correlated to the global economy and global trade. Thus, USD usually appreciates when growth & inflation slow (disinflation) and depreciates when growth & inflation accelerates (reflation). With expectations that growth and inflation will decelerate this year that should be a positive input for the USD. However, incoming data will also be important in relation to the ‘Fed Put’. There are many similarities between now and 4Q18, where the Fed were also tightening aggressively going into an economic slowdown. As long as growth data slows and the Fed stays aggressive that is a positive for the USD, but if it causes a dovish Fed pivot and lower rate repricing it would be a negative input for the USD.
3. CFTC Analysis
The USD came under some pressure this week, mainly due to overdue mean reversion, recovery in risk assets and of course the surprise hawkish actions by the BoE and more specifically the ECB. Keep in mind that half of the USD’s drop this week occurred outside the CFTC reference period which would explain more limited unwinding in net-longs, and we would expect this number to be much bigger next week. With positioning still in net-long territory for leveraged funds and large specs, and with leveraged funds sitting on a sizeable net-short in the EUR the recent hawkish pivot from the ECB could see some further damage for the USD in the short-term.
4. The Week Ahead
After last week’s much better than expected Average Hourly Earnings data out of the US, the main event for the USD as well as markets in general will be the January CPI print for the US scheduled for Wednesday. With another month of upside surprises for inflation data in other global economies, the markets will be watching the US CPI for Jan very closely. Right now, Fed policy has tunnel vision for inflation , and with the surprise beat in Friday’s NFP as well as the surprise punchy upward revisions, the labour market won’t deter the Fed from going all-in to fight inflation . The big dynamic to watch for is wages. Friday’s Average Hourly Earnings print of 5.7% was much higher than expected and saw an immediate jolt higher in US bond yields, with Fed Fund Futures now comfortably pricing in well over 5 hikes by the end of the year. Starting the new year, the biggest reason for expecting a deceleration in inflation was firstly due to base effects, secondly due to expectations that supply chain disruptions ease, and very importantly that commodity prices being cooling down. Out of these three, the last one has not happened yet with oil prices continuing their grind higher (which adds upside risks to headline numbers). Two important components to keep on the radar is wages and shelter prices, which for some means there is very little downside risk to this week’s CPI . How will the USD likely react? Recently the USD has reaction cyclically towards inflation data, which means a solid beat should be supportive, but at the same time a miss would be a far more attractive shorting opportunity, especially against the EUR after the ECB’s pivot .
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
Hawkish surprise with a hint of dovish undertones sums up the Feb BoE decision. The bank announced the start of passive QT and also hiked rates by 25bsp as expected, but the vote split was unanimous (9-0) but with a big hawkish surprise being 4 MPC members voting for a 50bsp hike. Inflation forecasts saw a big upward revision to a 7.25% peak by April ( prev . 6.0%) & 5.21% in 1-year ( prev . 3.40%). This initial hawkish statement saw immediate strength for GBP but during the press conference the BoE tried their best to get a dovish landing. Gov Bailey started his opening remarks by noting that the MPC’s decision to hike was not because the economy was strong but only because higher rates were necessary to return inflation to target, and even though he opened the door for further hikes he added that markets should not assume rates are on a long march higher. He also acknowledged the stagflation fears recently voiced by some market participants by saying that policy faces a trade off between weakening growth and higher inflation . Despite the dovish nuances, STIR markets still price an implied cash rate of 1.0% by May which would mean a 25bsp in both March and May (1.0% is the level the BoE previously said they would being outright Gilt selling). Overall, the statement was hawkish, but
the clear dovish undertones from the BoE was a bit surprising and also a bit worrisome for the future outlook.
2. Economic & Health Developments
There is a growing chorus of participants calling for a very tough road ahead for UK growth, and most recent Retail Sales data gave more confirmation to this expectation. Forecasts by the IMF/OECB still sees decent growth differentials, but not everyone shares that optimism (Refinitiv polling data). Even though the solid econ data going into Dec was enough to see the BoE hike, the overall rate expectations already priced in by markets are too ambitious. As long incoming data stay solid it should keep odds for additional tightening alive, but we should be mindful of repricing if the incoming data starts confirming a bleaker picture for growth.
3. Political Developments
The political uncertainty surrounding PM Johnson mean a higher risk premium for GBP. The fallout from the heavily redacted Sue Gray report was limited but reports over the weekend show a growing distrust for the PM from within his own party. The question remains whether enough MPs opt for a vote of no-confidence (if so, that could see short-term downside), but after that the focus will be on whether the PM can survive an actual vote of no-confidence, where a win is expected to be GBP positive and negative for Sterling if he loses. The North Ireland protocol is still in focus in the background with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, markets have rightly ignored this as political posturing, but of course any actual escalation could see sharp risk premium built into the GBP
4. CFTC Analysis
The CFTC data for GBP was very surprising. Recall that the downside in the GBP only started later during last week, which means that the very big increase in net-short positioning occurred while Sterling was still flying high. The question here is whether this was some political risk premiums building up or part of a bigger change in sentiment as concerns over the UK’s growth outlook continues to surface.
5. The Week Ahead
Just like the EUR, the biggest focus for the week ahead for Sterling will be on BoE talk. The bank tried really hard to get a dovish landing on Thursday, and any additional info and clarity from them will be keenly watched by market participants. With STIR markets pricing in an implied rate of 1.0% by May, one would have thought more upside is warranted for Sterling, but after the dovish undertones as well as the ongoing political challenges things are looking a bit messy for the GBP right now. If we see a similar divergence between ECB and BoE language like we saw at the press conferences that should put further upside pressure on EURGBP.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Jan FOMC decision was hawkish on multiple fronts. The statement signalled a March hike as expected, but Chair Powell portrayed a very hawkish tone. Even though Powell said they can’t predict the rate path with certainty, he stressed the economy is in much better shape compared to the 2015 cycle and that will have implications for the pace of hikes (more and faster). Furthermore, he explained that there is ‘quite a bit of room’ to raise rates without damaging employment, which suggests upside risks to the rate path. A big question going into the meeting was how concerned the Fed was about recent equity market volatility . But the Chair explained that markets and financial conditions are reflecting policy changes in advance and that in aggregate the measures they look at isn’t showing red lights. Thus, any ‘Fed Put’ is much further away and inflation is the Fed’s biggest concern right now. The Chair also didn’t rule out the possibility of a 50bsp hike in March or possibly hiking at every meeting this year, which was hawkish as it means the Fed wants optionality to move more aggressive if they need to. We didn’t get new info on the balance sheet and Powell reiterated that they’re contemplating a start of QT after hiking has begun and they’ll discuss this in coming meetings. Overall, the tone and language was lot more hawkish than the Dec meeting and more hawkish than consensus was expecting.
2. Global & Domestic Economy
As the reserve currency, the USD’s global usage means it’s usually inversely correlated to the global economy and global trade. Thus, USD usually appreciates when growth & inflation slow (disinflation) and depreciates when growth & inflation accelerates (reflation). With expectations that growth and inflation will decelerate this year that should be a positive input for the USD. However, incoming data will also be important in relation to the ‘Fed Put’. There are many similarities between now and 4Q18, where the Fed were also tightening aggressively going into an economic slowdown. As long as growth data slows and the Fed stays aggressive that is a positive for the USD, but if it causes a dovish Fed pivot and lower rate repricing it would be a negative input for the USD.
3. CFTC Analysis
The USD came under some pressure this week, mainly due to overdue mean reversion, recovery in risk assets and of course the surprise hawkish actions by the BoE and more specifically the ECB. Keep in mind that half of the USD’s drop this week occurred outside the CFTC reference period which would explain more limited unwinding in net-longs, and we would expect this number to be much bigger next week. With positioning still in net-long territory for leveraged funds and large specs, and with leveraged funds sitting on a sizeable net-short in the EUR the recent hawkish pivot from the ECB could see some further damage for the USD in the short-term.
4. The Week Ahead
After last week’s much better than expected Average Hourly Earnings data out of the US, the main event for the USD as well as markets in general will be the January CPI print for the US scheduled for Wednesday. With another month of upside surprises for inflation data in other global economies, the markets will be watching the US CPI for Jan very closely. Right now, Fed policy has tunnel vision for inflation , and with the surprise beat in Friday’s NFP as well as the surprise punchy upward revisions, the labour market won’t deter the Fed from going all-in to fight inflation . The big dynamic to watch for is wages. Friday’s Average Hourly Earnings print of 5.7% was much higher than expected and saw an immediate jolt higher in US bond yields, with Fed Fund Futures now comfortably pricing in well over 5 hikes by the end of the year. Starting the new year, the biggest reason for expecting a deceleration in inflation was firstly due to base effects, secondly due to expectations that supply chain disruptions ease, and very importantly that commodity prices being cooling down. Out of these three, the last one has not happened yet with oil prices continuing their grind higher (which adds upside risks to headline numbers). Two important components to keep on the radar is wages and shelter prices, which for some means there is very little downside risk to this week’s CPI . How will the USD likely react? Recently the USD has reaction cyclically towards inflation data, which means a solid beat should be supportive, but at the same time a miss would be a far more attractive shorting opportunity, especially against the EUR after the ECB’s pivot .