Pound beginning to feel the heat.
Despite its rally on Friday, Sterling is starting to come under pressure as its three pillars of support begin to weaken.
The economic data seen last week wasn’t suite as supportive as we have seen recently, in particular the index of services activity which feel close to a level which denotes a contraction in activity. This may have been the unseasonal weather or it may have been the first indication of service activity being moved from the UK to Europe in anticipation of Brexit. Service activity fell from 54 to 51.7.
Next month’s rate hike appears to be contingent upon next week’s inflation data. That may be a market observation but the MPC will need to heed what the economists and analysts think since it is them that they decision is directed at. The employment report will precede the inflation data and together they will paint a clearer picture of what the BoE are likely to do.
Finally, Brexit. Is it proceeding smoothly behind the scenes? Who knows? But traders are starting to get uneasy over the question of the Irish Border. The UK Government cannot simply capitulate as it has over other contentious issues as it will bring utter chaos, possibly leading to a General Election. As Michel Barnier says, “nothing is agreed until everything is agreed!”.
Employment report proves its worth!
And that worth is? A bit of activity on a usually dull Friday afternoon. Putting the data aside, the price action showed that the Euro retains the markets confidence while Sterling is beginning to falter.
Despite recent support between 1.2240 and 1.2260, the real line in the sand for the common currency is 1.2160. That is the level at which we can confirm that sentiment has moved against the euro. The rally for Sterling looks far more tenuous although it has managed to break above 1.04100 this morning. Any positivity for the pound is driven by dollar weakness and unlikely to last.
The employment report, apart from its comic value provided us with a glimpse into future inflation expectations as the rise in the rate of wage increases caught the eye. It was shy of the 3% that would have put four hikes back on the table, but it is moving in the right direction. The entirely ridiculous headline NFP would have won a few sweepstakes but gave no relevant insight into the underlying state of the U.S. economy.
The brewing trade war between China and the E.S. has pushed the Yen and Swiss Franc higher.
106.80/106.20 will be the area that starts to concern the BoJ as a strong Yen over the medium term will bring issues to the whole ethos of Abeonomics.
Euro in a good place, but what lies beneath?
The market retains a positive feeling towards the single currency but there are underlying concerns that could easily float to the surface in the coming weeks/months. The considerable and growing interest rate differential between the dollar and now possible Sterling should start to bring back the old differential play that was so favoured by “Mrs Watanabe”.
It was thought that “Mrs Watanabe”, the fictional Japanese housewife who thought she was acting cautiously by selling low yielding Yen for high yielders only to be buried under the global financial crisis had gotten divorced but maybe a whole new generation will start investing again!
Mrs Watanabe aside, one of the few criticisms that can be laid at the feet of Mario Draghi is that he has consistently “kicked the can down the road”, wherever possible, preferring to deal with the “now and not the when”
When the banks must deal with the huge bad loan portfolios they have it is going to bring a serious issue for the single currency as capital adequacy levels fall far below what regulators expect. A huge consolidation will take place which could go two ways. Either Eurozone members will withdraw within their own borders which will bring about serious questions over the viability of the whole “project”, or it will bring a new era of cross border Eurozone banks truly committed to the entire region.