News & Analysis

GBP

Political headlines continued to dominate the news cycle yesterday, but ongoings in Westminster did little to knock the pound off course as it joined other procyclical currencies in retracing against the dollar. If anything, Johnson’s resignation and the potential for more fiscal stimulus from his replacement in the coming months helped boost sentiment around the pound and expectations of the Bank of England’s hiking cycle this year. In terms of economic news, the central bank calendar drew all of the focus yesterday. The Bank of England’s latest decision maker panel was first up and saw firms expect to increase their selling prices by 6.3% over the next year, up from 5.9% in May. Additionally, firms now expect to increase wages by 5.1% over the next year, up from 4.8%. Although this may embolden hawks among the MPC, the inflationary developments were partially offset by a moderation in medium-term inflation expectations. A poll conducted by YouGov saw households’ medium-term inflation expectations fall from 4.2% to 4%, closer to the Bank of England’s 2% target. The moderation is likely due to the combination of policy tightening and deteriorating consumer confidence and will be welcome news to the Bank’s monetary policy committee as a whole. In addition to the decision makers survey, Chief Economist Huw Pill and MPC member Catherine Mann hit the wires yesterday, with both members outlining their willingness to tighten policy further should conditions deteriorate. Following yesterday’s 0.8% rally, GBPUSD is retracing somewhat today in line with the broad USD move. There is nothing scheduled in terms of economic data from the UK today.

EUR

Despite trading on a stronger footing for morning part of the European session, the euro sat under renewed selling pressure as US markets came online and European energy benchmarks starting to climb higher. As mentioned in yesterday’s morning report, the stagflationary risk of higher energy prices, especially heading into the winter with low European inventories of gas, means EURUSD and euro crosses are closely monitoring developments in energy markets. The benchmark for energy (Germany’s 1-year ahead energy baseload) continued to rise to record highs yesterday, with prices hitting €356 per megawatt. Although closer dated contracts remain below levels previously hit after the onset of the Ukraine war, the rise in the 1-year ahead contract highlights how Europe’s energy shortage is expected to be more structural and thus supplying a more persistent stagflationary shock. Outside of FX markets, peripheral bond spreads began to widen again in yesterday’s session after a Bloomberg story highlighted that the ECB has a working name for its new anti-fragmentation tool, the “Transmission Protection Mechanism”, but the framework of the tool is still yet to be decided upon by Governing Council members and that it may not be ready for the ECB’s next meeting. This could pose a hurdle to our base case assumption that the ECB shocks market expectations with a 50bp hike this month, but narrower spreads relative to last month’s peak suggests this may not be as much of a pressing issue than previously. Comparatively, signs that some ECB officials were already favouring a 50bp hike in July at last month’s meeting and the continued stagflationary pressure coming from a depressed EURUSD means our conviction in our call for the July meeting remains high. Today, focus will be on ECB President Lagarde’s speech at 12:55 BST at an event organised by Le Cercle des économistes.

USD

Markets were in risk-on mode again on Thursday, as investors bought equities and riskier currencies while selling bonds. That positive risk sentiment came once again off of no specific catalyst; rather, it’s simply the nature of a volatile market environment in which central banks are withdrawing stimulus, inflation is high, and growth is deteriorating. Although the dollar broadly weakened against procyclical currencies, the DXY index was practically unchanged due to weakness in EUR, JPY, and to a lesser extent CHF. Risk-on trading continued after initial unemployment claims were released at 13:30 BST / 08:30 EST, showing that jobless claims had surprisingly picked up from 231k to 235k despite economists expecting a slight dip to 230k. In this “bad news is good news” market, higher unemployment claims suggest that the Fed’s interest rate hikes are having their desired effect, marginally reducing the impetus to tighten policy to lower inflation. However, despite the initial signs of cooling labour demand, both FOMC members Bullard and Waller suggested that they would back a 75bp hike in July and reaffirmed their belief that the US economy will achieve a soft landing. On today’s calendar we have nonfarm payrolls at 13:30 BST / 08:30 EST. Given that money market pricing is quite full for a 75bp Fed hike on July 27 and that several FOMC members have backed another 75, it would take quite a large data surprise that points to increased labour market slack for expectations to come down to 50bps, especially as markets will likely await next week’s CPI data before fully adjusting their expectations for the July 27th meeting. Estimates currently sit at a 268k net employment increase, down from June’s 390k, with the range of forecasts spanning 90k to 400k.

CAD

The loonie closely tracked the move in pro-cyclical G10 currencies, the rally in WTI to back above $100, and the positive returns in US equity benchmarks as it rallied over half a percent against the dollar. Following yesterday’s session, which saw external factors drive price action in USDCAD, domestic data will take the lead for the loonie today. With US Nonfarm payrolls and Canada’s Labour Force Survey both released at 13:30 BST/ 08:30 ET today, any stark divergence in labour market conditions should prove decisive for USDCAD. Unlike the Federal Reserve, which can also assess June’s inflation data next week before its next decision, today’s LFS data will be the last major economic release for the BoC ahead of its July 8th meeting. Barring any sudden downturn in Canada’s labour market, we expect the BoC to hike rates by 75bps next week.

 

 

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