GBP/EUR 1.2678 (0.7887)
Yesterday we pointed out that a more subdued Fed led to a positive reaction in global markets, as the FOMC minutes pointed to a more subdued growth environment with risk to external forces, especially in Europe, US equity markets were rallying. This may appear somewhat counter intuitive but in recent years when central bank policy has been a key driver to markets globally, a weaker outlook means low rates, driving investors to look for yields elsewhere, equity markets have been attractive for investors looking for yields, especially while central banks were conducting QE programs.
The positive tone in markets turned sour yesterday as the reality appears to have sunk in. European stocks traded lower for the third straight day, while in the US session the S&P plunged, facing its largest decline since April and totally erasing the biggest rally of the year which occurred post FOMC minutes. Safe havens were in demand and on the currency front this led to gains in the JPY and USD against most other counterparts, with the JPY outshining the USD in the safe haven face off, looking for its first weekly gain against the greenback since August.
The big release of the day on paper was from the BOE, with an interest rate announcement due before lunch. The reality of this release is that it tends to come and go without much interest, there was no change expected from the BOE who once again held rates at .5% with their asset purchase target at £375 bln. Unlike the Fed or ECB, when MPC members decide no change in policy is warranted there is no statement released, leaving markets waiting for the minutes to try and analyse what way members are leaning with regard to forward policy.
Instead we prefer to keep an eye on the interest rate markets for indication on positioning for GBP pairs, interest rate swaps dropped to their lowest levels in 8 months while 2 year gilt yields have declined close to 25% in the last month, down to .726. While UK data has been softer of late, the NIESR GDP estimate has been consistent, the pound’s current positioning has reflected the recent run of weaker UK data and its future is likely to be shaped by key data points, next week we have inflation and labour market data, both key points in BOE policy, while up first this morning we have UK trade data on the wires.
The rally in EURUSD was firmly rejected ahead of 1.2800 with the pair already falling back below the 1.2700 marker. Safe haven demand for the USD and comments from the ECB’s Mario Draghi in Washington started the fall lower. We warned yesterday that should Draghi discuss the size of the QE’s program the EUR would remain vulnerable and we were not let down, while failing to provide any exact figures Draghi did pledge to expand stimulus measures if needed, while calling for structural reforms across Europe. This is nothing we haven’t heard before but it was enough to halt the short term EUR rally.
Another area of concern is capital flows into the region, the demand for higher yields has steadily supported the EUR through much of the early part of the year and the resulting inflow of capital into peripheral European debt certainly helped support the region, if these flows begin to unwind the region my face a far harsher slowdown than already predicted. Data from the region is light today, the announcement of the LTRO repayments headlines the European calendar, while several ECB speakers will be on the wires this afternoon from Washington.
The major bull rally in the USD may be taking a breather for now. The USD did claw back some ground through trading yesterday as risk aversion saw demand for the safe haven greenback but the Fed minutes and subsequent comments would once again reinforce our view that markets had got to hawkish on Fed policy. A number of Fed speakers were in action yesterday evening and the general consensus was that rates are unlikely to rise until the middle of next year, with considerable time cited as a period of 2 months to 12 months, while San Fran Fed president saw a first rate hike in mid 2015 as appropriate. Like the UK this going to be data dependant but while recovery remains mixed, rate hikes are likely to remain only speculation. There are plenty of Fed speakers on tap this afternoon, so eyes will be on their comments for policy implications.