What’s happening with currencies this week? Neil Parker, Market Strategist shares his views.
Rebound starting to slow, despite data remaining strong
The markets began last week in a confident mood about the possibility of a breakthrough on UK/EU trade talks; however, by the end of the week that optimism faded, replaced by concerns over the EU’s decision to start legal proceedings against the UK. The deadlock over key issues remained, with the UK government refusing to sign up to the EU’s demands on state aid, court jurisdiction and fishing. The negotiations look ever more likely to go down to the wire, and the risks of a no-deal remain high.
The UK data and surveys were more positive last week, with strength from house prices, an upward revision to Q2 GDP (Gross Domestic Product), and a pickup in one business barometer. Overall the figures offered only limited support to the pound, which continues to struggle to hold onto gains in the region of $1.2975 and €1.1050 against both the dollar and euro.
This week has already seen a strong outturn from the final September UK services PMI (Purchasing Managers’ Index). The reading was a full point higher than the initial outturn, suggesting that, at least thus far, the additional restrictions and localised lockdowns haven’t harmed activity too much. We have to wait until the end of the week for further data.
On Friday we are due to get a glut of releases, with August GDP, industrial production, index of services and construction output released. These should continue to point to a solid recovery underway, but note that the rate of recovery has been slowing. The UK suffered one of the worst declines in output over the months of March through to May, so it is no surprise that, superficially, it is enjoying one of the strongest rebounds. However, that rebound still leaves the UK someway behind the likes of Euroland and the US as we enter Q4.
For the GBP, we are approaching a zone where the pound has encountered resistance previously, just ahead of the $1.30 region and above €1.1050. Can it sustain a push higher, or will it fall back again? The risks are for more disappointment, given the uncertainty over the UK/EU trade discussions.
Inflation falls, as recovery tries to gain momentum
The figures from September Euroland inflation were troubling once again. Both the headline and core measures of inflation dropped, to -0.3% and 0.2% year on year respectively. These figures show that there is no inflation pressure in Euroland currently, and if anything the European Central Bank’s recent inflation projection is likely to be too optimistic with regard to the extent of the undershoot. The ECB (European Central Bank) will need to consider additional loosening in monetary policy, whether that is more money printing or even the possibility of negative interest rates. Real rates are negative, but only just, and so far the economy has not shown enough consistent improvement in activity to suggest that any inflation pressures will build.
There were some improvements in the survey data last week, but again nothing consistent to improve market confidence overall. The EUR bounced back, having had a difficult week prior to the last, but still looks unlikely to lay a glove on $1.20 over the coming sessions for any domestic fundamental reason.
This week has started slightly more positively, with the September services PMI for Euroland rising slightly versus the provisional reading. Overall however, the pace of the recovery is inconsistent with Euroland recouping its lost economic output over the next few quarters, and it may be more realistic to expect the full recovery to take until the middle of 2022. That will only add to the deflationary, or at best disinflationary, forces over the Euroland economy.
In the absence of any other particularly important data or survey releases, the EUR will be hoping for political or monetary policy direction to support it. Those look unlikely however, and the news that EU Commission President, Ursula von der Leyen is isolating after being in close contact with somebody who has subsequently tested positive for coronavirus, won’t have helped either. The EUR looks rangebound against other majors, for this week at least.
Strong data figures, but not strong enough to strengthen USD
Trump’s positive COVID-19 diagnosis and hospitalisation late last week raised additional concerns over the progress of the US election. Will he be well enough to participate in the two remaining debates, scheduled for 15th and 22nd October, and will he be able to fulfil his campaigning commitments as he looks to overhaul Democratic candidate, Joe Biden, in the November 3rd election? Trump has tried to downplay his condition, appearing in front of the cameras over the weekend, and doing a drive-past to thank supporters who had assembled outside the hospital where he was being treated. However, the conflicting reports about the seriousness of his condition has the potential to disrupt the markets if there is any hint that he might not be well enough to play a full part in the election.
The data and survey evidence from the US last week was relatively positive. The improvement from the confidence surveys and housing data caught the markets by surprise. The weakness in payrolls data was relative, in that 661k net jobs was still impressive, but well down on the rate of improvement seen in previous months.
Also last week, last ditch talks between the Democrats and Republicans over a bi-partisan fiscal stimulus package began. The House of Representatives passed a $2.2 trillion package of measures, but that was largely symbolic, and was never going to wash with Senate Republicans. A compromise package, around the $1.6 trillion mark, is on the table, but can it be modified sufficiently to placate Democrats without upsetting Republicans? That is the challenge for Pelosi and Mnuchin who are leading current negotiations.
This week is a quiet week for data and survey releases. There are a number of Federal Reserve speakers, including Powell on Tuesday, along with the FOMC (Federal Open Market Committee) meeting minutes on Wednesday. Given that some 11 million Americans remain displaced in terms of employment, the Fed may have to act in support of the US economy, especially if the government cannot reach agreement. So far the Fed has been reluctant to make additional loosening moves, instead imploring the fiscal authorities to throw their weight behind the US recovery, so far to no avail. Some further monetary printing is likely to be required, but perhaps not until the beginning of 2021.
The USD hasn’t been able to capitalise on recent strength, and now looks stuck in a range. There will be little fundamental reasons to alter the direction for the dollar over the next few weeks, and politics is likely to dominate. The risks for the USD are for a negative reaction to any bad news regarding Trump, and if his chances of winning the election continue to decline, then that could also prove USD negative as well.
Rest of the world
Australia is the focus of the week, with a cut possible
Last week was another quiet week on the central bank front, with no changes to policy from any of those due to announce. The central banking community will be watchful of inflation figures, which seem to be pointed to more aggressive deflation forces, as highlighted above in the Euroland section.
This week’s big central bank meeting is the Reserve Bank of Australia. They are set to announce early on Tuesday morning, and the markets think there is room for a cut of between 10 and 15 basis points. The economist community is less convinced, with the survey of 24 only seeing 4 predict a cut of 15 basis points, and the rest opting for no change. The contrast between the AUD having strengthened over the past week and a half, and some weakness in the Q2 GDP figures, versus the strength in the Aussie labour market figures, makes the RBA’s (Reserve Bank of Australia) decision difficult. However, disinflationary forces are likely to be the larger risk, so room for the RBA to cut is there if they want it.
Also this week sees the NBP (National Bank of Poland) and the Peruvian central bank meet. The NBP has interest rates at 0.1% and is unlikely to move on rates. Notably, at least one member of the NBP has expressed concern that having interest rates at record lows is having more of a detrimental effect on the economy than a positive one. The central bank of Peru is expected to stand pat as well, having cut rates to 0.25% in recent months. The Peruvian currency, the pen, has weaken over recent months against the USD, limiting any scope for further loosening.
To read the previous quick take, click here.
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