Potential seasonal gains

Despite facing significant resistance due to excessively optimistic GBP positioning, GBP is poised to benefit from favourable seasonal patterns.  April has historically been the strongest month for the GBP against the USD, with GBP/USD typically experiencing an average increase of 1.2% over the past two decades.  One explanation for this recurring trend is the surge in capital inflows into the UK driven by dividend payments to British shareholders from foreign companies and other investment inflows marking the commencement of the UK financial year.

Despite being largely overlooked by the markets, the latest GfK survey revealed a third consecutive month of improvement in German consumer sentiment, albeit from a subdued base. This marks the highest reading since the beginning of the year, reflecting slight upticks in income expectations and economic outlook. However, the willingness to make purchases remained largely unchanged, persisting at near two-year lows. The gradual and sluggish recovery of consumer sentiment suggests that a sustained rebound in the German economy will be a prolonged process. The IMF projects Germany's growth to reach only 0.5% in 2024, nearly half the pace of the Eurozone bloc.

EUR/USD struggled to breach the resistance level of the 200-day simple moving average at $1.0836, remaining within a short-term downtrend channel. In the immediate future, any further decline is expected to find support around the March lows of $1.0800. Investors are awaiting Eurozone economic sentiment and consumer inflation expectations reports later today, though neither is anticipated to significantly impact the market given the overnight option premium remains below its long-term average. Current indications suggest no significant increase in FX volatility, with EUR/USD 1-month realized volatility maintaining near 26-month lows.

USD/JPY has surged by more than 7% in the current quarter, establishing the yen as the weakest performer among major currencies thus far in the year. Despite the Bank of Japan's first interest rate hike since 2007, market sentiment suggests that the next rate increase may be postponed, leaving intervention by Japanese authorities as the primary means to curb the yen's decline.  Japan's finance minister has issued his most forceful warning yet regarding yen depreciation as USD/JPY approaches levels that prompted official foreign exchange intervention over a year ago, resulting in a 4% rally in the yen against its major counterparts in a single day.

 

EUR remains fragile

In March, the Confederation of British Industry (CBI) reported a slight increase in its monthly retail sales balance.  The indicator for yearly sales showed improvement, rising to +2 from the previous -7, marking an end to a 10-month streak of declines.  This stabilization in retail sales offers a glimmer of hope that the sector's downturn may be reaching its lowest point.  This news comes after recent official data revealed that British retail sales remained steady in February, defying expectations of a decline.  With the current pace of disinflation, reflected in a 1.5% 6-month annualized inflation rate, prospects for a consumer-led recovery in UK GDP growth are improving.

The recent dovish stance taken by the Bank of England (BoE) has bolstered expectations of interest rate cuts starting from June, potentially boosting consumer confidence and spending.  Money markets are even factoring in a possibility of a rate cut in May, contributing to the pound's weakness last week as UK gilt yields reached multi-month lows. Today, there are no significant UK data releases, so market sentiment and the strength of the USD are likely to influence the direction of GBP.

Another significant factor weighing on the GBP's strength is its positioning, with the currency being the most overbought among G10 currencies.  The 10-year median of net GBP long positions stands at -9.5% of open interest, but currently, these positions are around 23%. Although recent CFTC data indicated a reduction in net GBP long positions from a 17-year high to 53,200 contracts, down from 70,451, there remains a possibility of further unwinding of these long positions in the coming weeks.  While a surprise rate cut in May could act as a catalyst, it's not the base case scenario; however, it could potentially drive GBP/USD towards $1.20.

European equity markets kicked off the shorter week with a modestly upbeat tone, continuing a nine-week winning streak. The EUR found support around the $1.0800 mark against the USD, buoyed by a general weakening of the dollar and profit-taking activities ahead of month-end.  This occurred despite dovish remarks from a usually hawkish ECB policymaker, which stirred optimism that the central bank of the eurozone might initiate rate cuts in the near future.

Despite yesterday's rebound, the euro remains vulnerable to further weakness in the short term. Although the latest Gfk print for April showed a third consecutive rebound, it fell short of market expectations, dampening the ascent of EUR/USD.  Attention now turns to the US durable goods report later today.  If there's an upward rebound from last month's print, which marked the most significant monthly decline since April 2020, it could drive EUR/USD below the $1.0800 barrier, testing a 5-week low.

Furthermore, the surprise rate cut by the Swiss National Bank (SNB) last Thursday has raised speculation that the European Central Bank (ECB) will soon follow suit.  Given the history of the two central banks mirroring each other, albeit typically with the SNB following the ECB, the markets are anticipating further policy easing in the second quarter.  This anticipation is likely to keep a lid on EUR/USD upside potential, and the euro may struggle to advance against the USD without a fresh catalyst.

Monfor Weekly Update

The Bank of England opted to maintain rates at their 16-year peak of 5.25%, despite a decline in headline inflation from 4% to 3.4%, marking its lowest level since 2021. Analysts anticipate inflation will ease towards its 2% target in the forthcoming months, yet Bank officials remain keenly attentive to wage growth. The Bank's decision was split among its members, reflecting a lingering caution against premature rate cuts.

Market forecasts suggest the initial rate reduction may materialise in August, though June remains a viable option, with a collective 0.70% reduction anticipated for the year.

In parallel, the US Federal Reserve upheld its current policy stance, with Chair Powell emphasising the necessity for sustainable inflation alignment with targets. The Fed continues to anticipate three rate decreases throughout the year.

Meanwhile, the European Central Bank signals a hold on rates until June, awaiting substantial evidence to initiate an aggressive rate reduction cycle, with approximately 1% of cuts factored in amid a dim economic outlook, particularly evident in Germany's lagging performance.

Currency markets exhibit volatility within recent ranges, devoid of clear conviction or trend. GBP/USD hovers around 1.2600, descending from its recent yearly high near 1.2900, while GBP/EUR remains positioned towards the upper boundary of its established range of 1.1500 – 1.1750.

Focus shifts to forthcoming UK growth data, accompanied by quarter-end dynamics influencing market momentum.

GBP lower on dovish BoE

As anticipated, the Bank of England (BoE) maintained its Bank Rate at 5.25% yesterday.  However, the hold leaned towards a dovish stance due to the Monetary Policy Committee's 8-1 split in voting. Notably, the two previously hawkish members aligned with the majority to keep rates steady this time, whereas Swati Dhingra once again advocated for a rate cut.  Consequently, GBP/USD experienced its most significant decline in over a month, and GBP/EUR dropped to its lowest point in three weeks. This morning's UK retail sales data slightly exceeded expectations but remained stagnant in February, providing minimal support to the pound.

In a surprising move, the Swiss National Bank (SNB) reduced its main policy rate from 1.75% to 1.50%, marking the initiation of the monetary policy easing cycle and making it the first G10 central bank to do so.  The SNB's rhetoric, coupled with significant downward revisions to inflation forecasts, strongly indicate the likelihood of another cut in June. Consequently, EUR/CHF surged by 1.1% to reach a 7-month peak of CHF0.9787.  However, the extent of further gains hinges on the pace at which the European Central Bank (ECB) follows suit. In contrast,  Norway's central bank maintained its benchmark interest rate at a 16-year high of 4.50%, signalling a plan to reduce it only once by the end of the year. Initially, the Norwegian crown appreciated to NOK11.51 against the euro on ostensibly hawkish comments, but later declined to a 4-month low due to core inflation remaining nearly double the rate observed in the common bloc.

The USD experienced its most significant daily increase since early February due to disappointing data from Europe and a cautious tone from the Bank of England (BoE).  Nevertheless, the USD's responsiveness to robust macroeconomic indicators has been uninspiring, indicating investors' evident preference against the USD.  The USD's reaction to incoming data appears asymmetric, with weaker data having a more pronounced effect on the currency than positive surprises.  This doesn't imply that the USD cannot appreciate from its current levels, especially considering expectations for higher inflation in the US compared to the Eurozone and UK. However, the threshold for substantial USD appreciation in response to positive data surprises has elevated in recent weeks.

BoE expected to hold

As widely anticipated, the Federal Reserve (Fed) maintained its primary policy rate target at a 23-year peak ranging between 5.25% and 5.5%.  However, the spotlight was on the Fed's updated economic forecasts, particularly the Dot Plot, which indicated that officials still anticipate implementing three rounds of 0.25 percentage point rate cuts this year.  This suggests a belief that inflation is moderating sufficiently to warrant a reduction in borrowing costs. Correspondingly, the US dollar index dipped to one-week lows in sync with US yields, while US stock markets concluded at historic highs, and pro-cyclical currencies surged.

Revised rate projections by policymakers revealed a median interest rate expectation of 4.625% by year-end, consistent with December's figures.  Forecasts for the following two years and the long-term outlook were slightly elevated compared to the previous quarter, with only three reductions anticipated in 2025, down from the four predicted in December.  Although the overall dispersion of the Dot Plot leans more hawkish, with the median projection retaining three cuts for this year, officials emphasized that any future rate adjustments would hinge on data, economic outlook, and risk assessment. Fed Chair Jerome Powell adopted a dovish tone, suggesting that persistent early-year inflation might be attributed to "seasonal issues."  These remarks, along with the recalibration of Fed rate cut expectations, elicited positive reactions from investors, reflected in the S&P 500 surging past 5,230 and the Dow Jones achieving new all-time highs.

Today's focus shifts to the monetary policy decision of the Bank of England (BoE).  While the Bank Rate is anticipated to remain at 5.25%, the larger-than-expected decline in the UK inflation rate might prompt BoE officials to adopt a more dovish stance. Such a move could potentially weaken the pound, currently trading 0.7% below its seven-month high against the USD reached two weeks ago.

During the BoE's previous meeting in February, a rare three-way vote split occurred, including proposals for both rate hikes and cuts, marking the sixth instance of such divergence in the BoE's 295-meeting history and the first since August 2008. Historically, following such voting patterns, the central bank has often opted for rate cuts in subsequent moves, although this outcome seems highly improbable today.  Despite headline UK inflation sliding more than anticipated to 3.4% in February, down from 4.0% the previous month, with core inflation at 4.5% and service inflation remaining above 6%, we do not anticipate overtly dovish signals from the BoE in today's announcement. Money markets still indicate expectations of fewer than three 25-basis-point rate cuts by the BoE this year. However, given the recent downward surprises in inflation and softer indicators in the labour market, market pricing suggests approximately a 55% likelihood of an earlier rate cut occurring in June rather than in August.

 

Please note:  The news and information contained on this site should not be interpreted as advice or as a solicitation to offer to convert any currency or as a recommendation to trade.

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