The pound continued its freefall yesterday as it shed another percentage point and then some against the dollar to hit levels last seen in July 2020. The move in the pound was largely driven by a dovish realignment in Gilt yields and increased concerns over a recession, with two-year yields 28.7 basis points over the past three days to trade at 1.5%. Despite the moderation in UK bond yields, pricing in other fixed income instruments, like overnight index swaps and three-month SONIA futures, has remained fairly stable over the period in which the pound has been underperforming. The weaker pound comes just a week before the Bank of England is set to announce their next policy decision, with the currency weakness likely to cause headaches for policymakers as it only increases the inflation impulse through more expensive imports. This morning, the pound is trading fairly stable against the dollar as the greenback broadly weakens across the board, with little scheduled in terms of UK data beyond April’s consumer board reported retail sales for April at 11:00 BST.
The combination of continued market volatility, which broadly favours the US dollar on haven flows, and signs that Russia is set to cut gas flows through Bulgaria and Poland to the EU sent EURUSD through May 2020 lows to trade at levels last seen in 2017. While the greenback was broadly bid across the G10 space in yesterday’s session, the lows in EURUSD was the most notable development in the G10 as stagflation risks continue to linger around the eurozone macroeconomic outlook. The European Central Bank will likely have to prioritise tackling inflation by hiking interest rates at July’s meeting if the higher European gas prices persist, but markets are cognisant that this will naturally come at the expense of growth– which in the eurozone is already in a precarious position. With 75 basis points of hikes already priced into markets and growing expectations of a recession risk in the region, hawkish commentary from ECB members is unlikely to lift the single currency. That being said, ECB Chief Economist Philip Lane is set to speak imminently at 08:00 BST, with members Muller and President Lagarde pencilled in for 09:00 and 17:00 BST respectively.
The market risk-off move, induced by growth concerns in China at the start of the week, saw continued haven inflows into the US dollar. Fitting with a traditional risk-off session, Treasury yields fell as investors bought safe US government bonds, which helped the Japanese yen recover somewhat as yield differentials between the US and Japan eased. The slight rally in the yen has proven short-lived, however, with all gains reversed already this morning. All eyes will be on the Bank of Japan’s meeting on Thursday and whether the central bank will widen the parameters around its yield curve control policy on 10-year Japanese government bonds from +/- 0.25%, or whether the central bank will have to step into FX markets to defend the yen if it doesn’t. With the two largest components of the DXY index, the euro and the yen, both trading at historic lows, further upside in the DXY index is likely over the course of the week. However, signs of a more fragmented dollar are visible in G10 markets today, especially as depreciation in the Chinese yuan starts to moderate. Following a stronger than expected CPI reading out of Australia, the Aussie dollar leads gains in the G10 space this morning, with other commodity currencies following suit with slight gains against the greenback.
The loonie continued to weaken against the greenback on Tuesday as investors sought safety amid highly elevated levels of market volatility. The main macro catalysts for the increase in volatility—which we’ve seen not only in FX, but other markets such as equities and bonds—appear to be a continued escalation of the Russia-Ukraine war and renewed fears that Covid-induced lockdowns in China could weigh on global demand. Russia’s foreign minister, Sergei Lavrov, warned Western nations on Monday that the risk of nuclear war is “serious.” Meanwhile, residents of Beijing have begun mass stockpiling goods in anticipation of a draconian Shanghai-style lockdown. Given that the move in USDCAD appears to be driven largely by risk premium rather than underlying economic fundamentals (i.e. inflation, jobs, productivity), it’s likely that the currency pair will begin to mean-revert after Russia-Ukraine and China developments stabilise and cross-market volatility falls to more normal levels.