Sterling initially enjoyed the Bank of England’s decision to hike rates by 25bps to 0.5% yesterday and begin balance sheet reduction by ending the reinvestment of maturing Gilts. This was largely due to the hawkish undertones within the rate statement as a rate hike of this magnitude was fully priced in by money markets. The pound spiked on the news four of the nine monetary policy committee members voted for a 50bps rate hike at yesterday’s meeting and the news that the Bank is actively selling its corporate debt as opposed to letting maturities roll-off of the balance sheet like it is doing with its Gilt holdings. However, the pound’s rally, especially against the euro, wasn’t to last as Governor Bailey managed expectations in the press conference and emplored markets to not read too much into today’s decision. This saw FX pricing largely disconnect from money market pricing as the pound relinquished its early gains while overnight index swaps continued to price UK rates hitting 1.5% at earlier meetings this year. Then, following the ECB meeting and the mammoth rally in the euro, GBPEUR dropped like a stone after touching recent pandemic highs to trade at its lowest level in weeks. While the break lower in GBPEUR arguably helped the pound rise against the dollar yesterday as markets were reluctant to let the cross plummet too much, this morning, momentum continues to favour euro bulls. GBPEUR is currently trading at fresh year-to-date lows, with US labour market data the only event on everyone’s lips today.
Yesterday was a good day for EUR bulls who had been stomaching various downside euro narratives that had been weighing on the single currency for most of January. The change in tone in the European Central Bank meeting was the main driver of this turnaround in EUR sentiment as ECB President Lagarde emphasised risks to the medium-term inflation outlook, paving the way for a potential shift in overall policy at March’s meeting, and refused to reiterate her comments in December that the central bank won’t hike rates this year despite being explicitly asked by two journalists. Going into the event, the broad consensus was for the ECB to reference the upside risks to inflation while at the same time pushing back on market expectations for interest rate hikes, rather than emboldening them. Money markets are now pricing 50bps of hikes from the central bank this year, enough to bring the deposit rate out of negative territory. EURUSD jumped higher on the back of this shift, along with the 2-year German Bund yield which sharply spiked to levels last seen in 2015. If the inflationary pressures in the coming months are driven by stronger wage growth and increasing second-round effects, the ECB is likely to increase its pace in which it winds down its pandemic bond-buying programme and to signal to markets a Q4 rate hike is likely. This should keep the euro well-bid in the near-term. This morning’s factory orders from Germany which printed to the upside emboldens this view, while markets now turn to US labour market data at 13:30 GMT for further trading impetus. Any negative surprise in the data will only embolden EUR bulls and would likely see fresh year-to-date highs in EURUSD.
Despite yields on the US 2-year heading back towards recent highs, and JPY sustaining losses due to this, the DXY continued to plummet as the euro led gains within the G10 space after the hawkish ECB meeting. The jump higher in the euro, due to increased concerns over the eurozone inflation backdrop, also sent SEK and NOK higher against the dollar. The broad depreciationary pressure on the dollar from Europe resulted in other procyclical currencies, such as CAD and NZD, also rallying against the greenback. The DXY index remains under pressure this morning, largely due to price action in EURUSD, with the DXY index poised to close the week 2% lower. This would mark its worst week since March 2020. With the dollar bears emboldened and US yields struggling to price higher expectations of the Fed to offer a leg of support to the greenback, today’s nonfarm payrolls data will be crucial. A negative reading in the ADP data on Wednesday suggests that today’s payrolls figure will be bleak. Expectations are for just 125K jobs to be added, largely due to the impact of Omicron but also the flailing employment gains due to limited labour market slack. If expectations are met and the net employment figure doesn’t print negative like the ADP measure, January’s net employment gains would be the lowest since the Delta variant in December 2020. Given the limited labour market slack, focus will also be on the participation rate and wage growth measures as these are highly influential for Fed policy at present. The data is due out at 13:30 GMT and is likely to fuel fresh volatility in G10 FX markets.
Despite the broad decline in the US dollar over the course of the week, the loonie has been trading in relatively tight ranges. The currency’s struggle against the greenback in yesterday’s session, despite the broad bid in procyclical currencies due to the EUR strength, was telling. It suggests that markets are more cautious about the ability of North American economies’ to keep up with their hawkish rate profile. Today’s labour market data will be a good litmus test in this regard. Although the data is set to be impacted by the arrival of the Omicron variant, the extent of the unwind in overall employment will be key in determining the true level of slack in the economy. Given expectations of a shorter lockdown this time around, and hiring difficulties in the run-up to the Omicron arrival, one would expect firms to be more reluctant to release workers this time around. Expectations are for employment to drop by 110K in January, raising the unemployment rate from 6% to 6.3%. However, the industry split of the job losses along with their concentration in part-time work will be key in determining the market reaction.