British Pound Under Pressure Amid Economic Data and Market Sentiment

The British pound remains under pressure this week, hitting its lowest level in nearly a month against the US dollar on Monday. GBP/USD dipped below $1.31, while GBP/EUR fell closer to €1.19, despite rising UK bond yields. The cautious market sentiment during the Asian session, fuelled by a lack of Chinese stimulus announcements, added to the pound’s struggles as it is a risk-sensitive currency.

Data released yesterday revealed that UK salaries increased at the slowest rate in three-and-a-half years in September, signalling a softening labour market. The rising number of job candidates and decreasing demand for staff contributed to wage growth for permanent hires slowing to its weakest since February 2021. This bolsters expectations of more aggressive rate cuts from the Bank of England (BoE). However, despite the soft labour data, UK gilt yields surged to multi-month highs following the strong US jobs report, lending some support to the pound.

Additionally, today's data shows UK retail sales rose by 1.7% on a like-for-like basis in September compared to the same period last year, marking the fastest growth in six months, driven by higher spending on clothing as the holiday shopping season kicks off.

Despite the recent dip, the pound remains the best-performing currency year-to-date, up over 3% against the dollar. With speculative traders still net bullish on the pound, this could prompt profit-taking as year-end approaches, especially with upcoming uncertainties surrounding the UK Budget and the US presidential election.

Euro Struggles Below $1.10 as Economic Weakness and Rising Oil Prices Weigh

The euro remains under pressure, trading below $1.10 this morning, with European equities set to open lower. Chinese markets have also lost momentum since Friday, underperforming global peers. Oil prices have surged, with Brent crude climbing above $80 per barrel for the first time in six weeks, driven by geopolitical tensions between Iran and Israel, impacting pro-cyclical currencies.

The euro's main challenge comes from the reduced expectations of Federal Reserve rate cuts this year, coupled with continued weakness in the German economy. German factory orders dropped 5.8% in August, marking the steepest decline since January 2024. Inflation across major Eurozone economies has also fallen below 2%, increasing the likelihood of a 25 basis point interest rate cut by the European Central Bank (ECB) next week.

Although ECB policymakers have signalled the market to prepare for this rate cut, rising US Treasury yields, driven by strong economic data, have kept German Bund yields from falling. This alignment of monetary policies between the ECB and the Fed has weighed on the EUR/USD exchange rate, which fell from $1.12 to below $1.10 last week.

Pound Faces Worst Week Since July 2023 Amid Economic Pressures

Last week the British pound experienced its steepest weekly decline since July 2023, dropping by 1.8% from $1.34 to $1.31 against the US dollar. Sterling was weighed down by a combination of risk aversion, strong US economic data, and dovish remarks from Bank of England (BoE) Governor Andrew Bailey. As a result, the market has adjusted to anticipate consecutive interest rate cuts in the UK, reducing the rate advantage that had supported the pound earlier in the year.

Upcoming UK GDP data for August, set to be released on Friday, will reveal whether the economy returned to growth after stagnating in July. Meanwhile, downward revisions to final Q2 GDP data and September PMIs have opened the possibility for more aggressive monetary easing than initially expected. This shift, coupled with weakening growth and yield differentials, could keep demand for the pound subdued, potentially testing the $1.30 level for GBP/USD soon.

Despite the recent fall, the pound remains the best-performing G10 currency year-to-date. GBP/USD continues to hold within the top quarter of its 1-, 2-, and 3-year ranges, sitting three cents above its five-year average of $1.28.

U.S. Jobs Report Exceeds Expectations, Easing Concerns Over Labour Market Weakness

The September U.S. jobs report showed unexpectedly strong growth, with the labour market adding 254,000 net new jobs, far surpassing the forecasted 150,000. Additionally, July and August figures were revised upward, breaking the trend of downward adjustments seen in previous months. The unemployment rate also dipped to 4.1%. Combined with earlier data showing steady demand for workers, the report eases fears of a weakening U.S. labour market.

As a result, markets are now pricing in around 50 basis points of easing from the Federal Reserve by year-end, down from the 75 basis points anticipated two weeks ago. The next key test for Federal Reserve policy expectations is this week's U.S. CPI inflation report. However, it is unlikely to reignite expectations of large cuts, keeping the U.S. dollar stable around current levels.

The U.S. economy's resilience, along with diminishing bets on aggressive Fed easing, suggests the dollar's strength could persist. However, improved hopes for a soft landing, combined with China's recent stimulus measures and rising energy prices, may also lift global risk sentiment. In this environment, G10 high-beta currencies, especially those tied to higher commodity prices like the Australian dollar (AUD), Canadian dollar (CAD), and Norwegian krone (NOK), could perform well against the U.S. dollar.

The upcoming U.S. CPI inflation report this week will be the next key indicator for Fed pricing and, consequently, the U.S. dollar.

EUR/USD Falls Below $1.10 as Diverging Central Bank Policies Weigh on Euro

Last week's strong U.S. economic data sharply contrasted with weak Eurozone indicators, such as sluggish manufacturing PMIs and softening inflation. This divergence led to a re-pricing of both central banks' monetary policy outlooks, pushing EUR/USD below $1.10 for the first time in seven weeks. The U.S. Federal Reserve's policy trajectory remains the primary driver of the euro's decline.

Weaker economic activity and faster disinflation in the Eurozone have impacted European Central Bank (ECB) communications and market expectations, with a 95% probability now priced in for a 25-basis-point rate cut in October. As expectations for ECB rate cuts rise, while bets on U.S. Federal Reserve cuts diminish, the narrowing gap in easing expectations has dragged the euro lower. Despite stimulus efforts from China, EUR/USD has struggled to break above $1.12, indicating that any upward movement will depend on U.S. data, monetary policy developments, and factors like the U.S. election and trade policy.

This week, market attention will focus on Eurozone retail sales, ECB meeting minutes (Thursday), and comments from several ECB Governing Council members. With persistent economic weakness and the ongoing pace of disinflation in the Eurozone, further dovish signals from the ECB are likely to keep EUR/USD under $1.10 in the near term.

All Eyes on Key US Data

The US dollar has continued its recent recovery as yields on two-year and 10-year bonds climbed to their highest levels in weeks. This move was driven by Federal Reserve Chair Jerome Powell’s slightly hawkish tone, alongside robust US economic data. Additionally, safe-haven demand for the US dollar, prompted by the escalating conflict in the Middle East, has further buoyed the currency.

In the short term, the dollar’s bullish momentum is expected to persist, underpinned by weakness in other major currencies and ongoing haven demand. The US’s economic strength is also providing support, with the ISM services PMI rising at its fastest pace since February 2023. Nonetheless, the dollar’s longer-term trajectory still leans lower amidst the global easing cycle. Despite this week’s data causing traders to scale back expectations of Fed rate cuts, the odds of a half-point cut in November remain around 65%. Although further cuts are priced in more aggressively for the Fed compared to the ECB and BoE, this could cap the dollar’s gains. However, if yields remain elevated despite rate cut expectations, the dollar could stay supported through November. Market sentiment is also shifting; FX options traders are now the most bullish on the dollar since July, though upcoming US payroll data could change the narrative once again.

Today’s jobs report may well be the pivotal factor determining the Fed’s decision next month. A below-consensus non-farm payrolls figure could see markets price in a greater chance of a substantial 50bp cut in November, thereby weakening the dollar. Conversely, a stronger-than-expected print would support the argument for a more modest 25bp cut, putting the dollar index on track for its strongest week since April.

Bailey’s Comments Send the Pound Reeling

The pound has been hit by a triple whammy of risk aversion, strong US data, and dovish remarks from the Bank of England (BoE). Increased demand for safe-haven assets due to geopolitical tensions, coupled with the pound’s sensitivity to risk, delivered the first blow to GBP/USD. Stronger US data and hawkish signals from the Fed gave the dollar an additional edge. However, the knockout punch came from BoE Governor Bailey, who hinted at a more aggressive approach to rate cuts if inflation continues to ease.

GBP/USD is set for its largest weekly decline since July 2023, having dropped around 1.7% so far. Money markets now fully price in a 25bp cut in November and a 70% chance of another in December, up from around 40% earlier this week. Six rate cuts, up from five, are now priced in by the end of 2025. We have been vocal about the disconnect between BoE pricing and that of its peers, viewing a dovish recalibration as the primary risk to sterling’s outlook. The pound fell by over 1% against both the dollar and the euro following Bailey’s comments, with GBP/EUR posting its worst day since 2022. With bullish GBP positions becoming crowded, the risk is that the pound could decline more sharply if these positions unwind. Sentiment in GBP options has already turned the most bearish since mid-August.

Will the BoE’s Chief Economist, Huw Pill, offer any support for the pound today? Pill, who was one of the dissenters at the August BoE meeting in favour of holding rates, could temper Bailey’s recent dovish tone. However, for the pound to truly recover, a combination of positive UK economic data and a de-escalation of Middle Eastern tensions would be required.

Euro Erases Year-to-Date Gains

The broad euro index has rebounded from three-week lows, supported by upward revisions to the Eurozone services and composite PMIs. Gains of over 0.4% against both the NZD and AUD were bolstered by cautious market sentiment amid the ongoing Israel-Iran conflict, while the pound’s weakness following dovish comments from BoE Governor Bailey led EUR/GBP to surge nearly 1% on Thursday. Nonetheless, EUR/USD remains under pressure as diverging rate expectations continue to weigh on the pair. Market participants have pared back bets on Fed rate cuts, while expectations for an ECB rate cut at its October meeting have increased, putting additional pressure on the euro.

The Eurozone composite PMI was revised higher to 49.6 in September, up from an initial estimate of 48.9, but it still entered contraction territory for the first time since February. While the services sector slowed (51.4 vs 52.9) and manufacturing contracted further (45 vs 45.8), demand for goods and services in the euro area fell at its fastest pace in eight months, leading to backlog reductions and an accelerated rate of job cuts. Business confidence has also softened slightly.

As a result, European equities have declined for the fourth consecutive day, with month-to-date losses approaching 3%. Meanwhile, implied EUR/USD volatility rose to a two-week high ahead of the US non-farm payrolls report. Short-term risk reversals now favour euro puts, reflecting the most bearish sentiment since early August. Unless US jobs data disappoints, the euro is likely to continue its decline, reflecting the region’s ongoing weak fundamentals.

Sterling Extends Decline Following Bailey’s Caution

The pound has held the title of the best-performing G10 currency for most of 2024. However, its high sensitivity to global risk sentiment has seen it weaken against safe-haven and commodity-linked currencies amid heightened geopolitical tensions this week. As we had cautioned recently, the greatest risk to sterling was a dovish recalibration of Bank of England (BoE) rate expectations. Consequently, Governor Bailey’s comments suggesting that the BoE could accelerate its rate-cutting cycle have placed further downward pressure on sterling.

Against the US dollar, the pound has retreated sharply from last week’s 31-month highs above $1.34, now trading below $1.32. However, it still remains nearly four cents above its 5-year average of $1.28, and the pair is holding within the top quartile of its 3-year trading range. Elevated rate differentials had previously supported GBP/USD around the $1.34 mark, but this dovish shift by the BoE reduces the pound’s appeal. Moreover, should market expectations for Federal Reserve easing be scaled back further, driving US yields higher, the pound could face increased downside risk. Reflecting growing market stress, one-week implied volatility in GBP/USD has risen to its highest level this year. FX options traders, who were the most bullish on sterling versus the dollar in four years just last week, have now turned sharply bearish on both weekly and monthly tenors.

Against the euro, sterling has slipped below the key €1.20 level but remains up 3.7% year-to-date. While the euro is grappling with economic and political uncertainty, the downside risks for this pair may be more contained than for GBP/USD.

Dollar Gains Support from Safe-Haven Demand

Geopolitical risk remains a primary concern for investors, but following the market turbulence that triggered a flight to safety and caused oil prices to surge over 5%, sentiment has stabilised somewhat. While it’s important not to overreact to geopolitical developments, the potential knock-on effects on monetary policy are worth considering.

For now, Federal Reserve (Fed) policy is largely dependent on the direction of the labour market. Following stronger-than-expected job openings data on Tuesday and a robust ADP employment report yesterday, markets have scaled back their expectations for Fed easing by year-end. Less than 65 basis points of rate cuts are now priced in, compared to 80 basis points last week. The ongoing dockworkers’ strike in the US, the first of its kind since 1977, has also contributed to this shift, as it threatens to disrupt supply chains, posing an inflationary risk. Meanwhile, if the Middle East conflict continues to drive energy prices higher, inflation could become a renewed concern should the situation escalate further. This supports the current scepticism towards aggressive Fed rate cuts, and it’s one reason why the dollar’s rally could persist in the short term.

The dollar is also benefiting from its status as a safe-haven currency, so it’s not surprising to see it appreciate against most of its peers this week. Investors will remain highly sensitive to geopolitical developments, but also to any data that challenges the narrative of a soft landing or the extent of policy easing currently priced in. October has a reputation for heightened volatility, and with the US election just weeks away, we are likely to see continued elevated demand for safe-haven assets.

Euro Retreats Amid Cautious Sentiment

The euro fell back to find support at its 50-day Simple Moving Average (SMA) of $1.1040, its lowest since 12th September, as geopolitical tensions continued to weigh on currency markets, albeit less severely than the previous day. European equities remained subdued, with the Stoxx 50 posting only marginal gains, while the French CAC and German DAX lagged behind. European bonds were sold off as Tuesday’s risk-off sentiment abated, pushing the German bond yield curve higher, with the long-end experiencing the greatest repricing. However, the 2-year DE-US spread held steady at around 160 basis points, its widest level in six weeks, putting pressure on the euro. The common currency weakened against most G10 currencies except the CHF and JPY, gaining 1.6% against the latter after Japan’s Prime Minister ruled out near-term rate hikes.

While not market-moving, the Eurozone unemployment rate remained unchanged at 6.4% in August, in line with expectations. Given the light macroeconomic calendar, attention has shifted to geopolitical and political developments. French Prime Minister Michel Barnier announced plans for €60 billion in spending cuts and tax increases next year, aiming to reduce the budget deficit from 6.1% to 5%. President Macron also endorsed a temporary tax on large corporations, marking a notable shift in his pro-business stance. Market reaction was limited, with the 10-year OAT-Bund spread narrowing slightly but remaining near its end-June highs.

With the next European Central Bank (ECB) policy decision just two weeks away and a lack of major data releases in the interim, investor focus is on remarks from ECB officials. A growing faction within the Governing Council acknowledges the increasing downside risks to growth, and with inflation below the ECB’s 2% target, a 25 basis point rate cut at the upcoming meeting is now widely expected. The Overnight Index Swap (OIS) curve is currently pricing in a 96% probability of a cut, up from 40% last week.