Market Rebound Continues Amid Easing Volatility and Focus on US Jobless Claims
Equities have continued their rebound, cryptocurrencies have surged higher, and the US dollar is grappling with pro-cyclical foreign exchange as the recent financial panic subsides. This renewed risk appetite is supported by a modest decrease in volatility, though the VIX "fear index" remains significantly above its long-term average. Today's focus is on the weekly US jobless claims figures, following last week's sharp slowdown in payroll growth and rise in unemployment, which heightened recession concerns.
On Monday, our financial sentiment index turned negative for the first time this year due to the flight to safety, increased demand for downside protection, and spike in market volatility. This shift has provided some support for the US dollar against its pro-cyclical counterparts. However, with US economic growth weakening and the Federal Reserve expected to begin its easing cycle in September, we anticipate further dollar depreciation in the medium term. The extent of this decline will depend on the global growth outlook and US political developments.
Traders are speculating that the Fed might start its loosening with a larger-than-average 50-basis point cut in September, but significant deterioration in the labor market would be necessary for such an aggressive move. Unless next week's US CPI data presents a surprise, the attractiveness of USD rates appears diminished, and if the dollar index falls below 102, the psychological threshold of 100 could be within reach.
Sterling Struggles Amid Market Calm, Needs Fresh Catalyst for Revival
Despite the dust settling after the market turmoil at the start of the week, sterling continues to struggle against its major peers. GBP/USD is flirting near key moving average support levels on the daily chart, around $1.27, while GBP/EUR is edging closer to €1.16, primed for another 1% weekly decline. It's clear sterling needs a fresh positive catalyst to resume its climb from the first half of 2024.
Revised UK GDP data wasn’t such a catalyst. It turns out that 2022 was better than statisticians thought, as UK GDP jumped 4.8%, instead of the 4.3% previously estimated, according to annual revisions. The data suggest the economy was showing underlying resilience even as it began to be roiled by Russia’s invasion of Ukraine, which sent inflation in Britain surging to a peak of 11.1% in October 2022. The impact of the cost-of-living crisis later triggered a recession and slowed annual GDP growth to just 0.1% in 2023. However, the economy has bounced back more quickly than many forecasters had expected this year as the surge in inflation fades.
The Bank of England’s (BoE) interest rate cut, coupled with the fall in inflation, has reduced the pound’s real yield appeal. Additionally, speculative positioning was heavily stretched in favour of sterling bulls coming into the second half of the year. Hence, the bullish drivers of sterling strength have weakened of late, but we think a sustained improvement in global market risk appetite should act as a welcome relief for the UK currency alongside the brighter UK growth outlook.
Improved Market Sentiment Boosts European Equities and Stabilises EUR/USD
Market sentiment improved further on Wednesday, with European equities climbing higher and Bund yields recovering to pre-NFP levels. Bunds edged lower for a third day as investors continued to unwind haven buying, and the EUR/USD spot rate remained largely stable around Wednesday’s open rate of $1.083.
Bund yields are likely to continue trading in lower ranges as European Central Bank (ECB) and Federal Reserve (Fed) rate cuts are anticipated. In the Eurozone, the market’s assessment of recession risk remains elevated, as incoming data does not show a marked improvement. Yesterday’s macro data from Germany showed a sharp fall in exports, which was counteracted by better-than-expected industrial production growth in June. This suggests that while the export-oriented growth model is fundamentally struggling, there could still be a small cyclical improvement in the second half of the year.
With assistance from soothing comments by the Bank of Japan, the euro rallied against the safe haven currencies JPY and CHF by more than 1.4% but continues to trade lower compared to a week ago. Having rallied close to 2% over the past five days, EUR/GBP has eased from near three-month highs and is now below the £0.86 level. Money markets continue to trim ECB rate-cut bets, pricing in 68bps of easing by year-end compared to 71bps the day prior. Investors are more hesitant to price out Fed easing at the same pace, thus maintaining EUR/USD relatively supported for now.
With the domestic calendar empty, the only key risk event is the US initial jobless claims. We can expect volatility following the release of this report, as market participants will be looking for data to support or disprove the belief that the US labour market is slowing faster than the Fed expects, thereby justifying the current OIS curve pricing.
