Pound's Journey: From Best to Worst Performing G10 Currency
The pound has shifted from the best-performing G10 currency this year to the worst in August, influenced by fluctuating global risk appetite and increasing bets that the Bank of England (BoE) will cut interest rates twice more this year. Despite this, the BoE remains the least dovish among its G3 peers, and today's mixed UK jobs report further complicates the policy outlook. Sterling has ticked higher, currently trading around $1.28 and €1.17 against the USD and EUR respectively.
UK Job Market Surprises as Wage Growth Cools
In the three months to June, the UK economy created more jobs than expected, causing a surprising drop in the unemployment rate from 4.4% to 4.2%, below the forecast of 4.5%. However, wage growth slowed to its lowest pace in nearly two years, falling from 5.8% to 5.4%, signalling a cooling labour market. Despite distortions in the labour market survey, the wage figures align with officials' expectations, leaving rate forecasts unchanged. Meanwhile, CFTC data shows a significant reduction in GBP longs last week, despite their proximity to multi-year highs. Sterling remains vulnerable as crucial data, including inflation figures tomorrow and preliminary GDP data on Thursday, could influence future bets.
Inflation Outlook and BoE Rate Cut Speculation
Wednesday's inflation data is expected to show a 2.3% year-on-year rise in consumer prices for July, consistent with June's target. However, core and services inflation, which are more closely watched, are expected to soften. Consequently, UK overnight indexed swaps are increasingly pricing in nearly two rate cuts from the BoE before year-end.
FX Market Volatility and Caution Amid US Slowdown Concerns
FX markets have experienced a turbulent summer, driven by increasing concerns about a more pronounced US economic slowdown and questions about the Federal Reserve's prolonged high-interest rates. However, with volatility indices stabilizing and a positive ISM services report in the US easing recession fears, risk appetite has firmed, supporting pro-cyclical FX and reducing haven demand.
A slowing US or global economy presents a complex scenario for FX markets: a slowdown from above-trend output typically pressures the US dollar, but a slowdown leading to a negative output gap tends to support the dollar due to its safe-haven status. Currently, stability in equity markets has led investors to adjust their expectations for the Fed’s September meeting, now anticipating a 25-basis point rate cut instead of the previously expected 50 basis point cut. Short-dated yields have stabilized above 4%, and the US dollar index is around 103. Despite weakening growth and yield appeal, this transition phase introduces near-term downside risks for the US dollar without necessarily overturning the strong dollar regime, especially with ongoing structural factors such as protectionism/tariff risks and increased US fiscal stimulus.
Today, the focus is on NFIB small business optimism and US producer prices. Investors may breathe a sigh of relief if July’s headline and core PPI come in softer than June as expected. However, geopolitical tensions persist, with the US warning of a potential Iranian attack on Israel this week, which could limit any risk rally and keep the safe haven dollar in demand.
Euro Stays Steady as US CPI Report Looms
Financial markets started the week calmly, with the European equity index Stoxx50 ticking marginally higher on Monday and demand for government bonds easing. The EUR/USD pair remained stable, fluctuating within a narrow range of $1.0915-$1.0935 as investors adopted a cautious approach ahead of the crucial US CPI report scheduled for later this week. Volatility is expected to remain subdued until this data release.
Germany’s ZEW Economic Sentiment report for August is due soon, with expectations of further deterioration marking the second consecutive month of decline. The eurozone’s private sector growth stalled in July, with Germany dragging down the region’s overall performance. The German economy is teetering on the edge of stagnation, especially after the unexpected contraction in the second quarter. If the ZEW report confirms a bleak outlook, it could reinforce concerns about Europe’s growth prospects. However, the impact on the euro may be limited, as investors focus more on US macroeconomic data for cues on the EUR/USD direction.
Geopolitical tensions, particularly the ongoing Russia-Ukraine conflict, remain a background concern for investors. The recent rise in European gas prices to €41.4 per megawatt-hour, a nine-month high, underscores the potential risks. Historical patterns from 2022 suggest that any significant increase in fossil fuel prices tends to benefit the US dollar, as it signals broader economic risks that drive investors toward safer assets like the greenback.
