Yesterday, the Bank of England raised rates via a 9-0 vote, but Governor Carney’s remarks may have interpreted as somewhat more cautious than the vote result suggested and thus, the pound tumbled. As for today, the spotlight is likely to fall on the US employment report for July. Following Wednesday’s upbeat FOMC statement, a solid report could further strengthen the case for two more hikes by year end.
The pound traded lower against most of its G10 peers on Thursday. It gained only SEK and NZD, while it traded virtually unchanged against NOK. The British currency underperformed the most against USD, CAD and JPY.
Yesterday, the big event for pound traders was the Bank of England policy decision. The Bank decided to increase interest rates to 0.75% as was widely anticipated, but via a 9-0 vote instead of 7-2 as the consensus suggested. In the summary accompanying the decision, officials reiterated that if the economy continues to develop in line with their projections, further policy tightening would be appropriate, but still at a gradual pace and to a limited extent. The pound surged around 55 pips against its US counterpart at the time of the release, but the joy for sterling bulls did not last for long.
The currency took a 180-deegree turn and tumbled near 100 pips during Governor Carney’s press conference. In his opening remarks, the Governor said that a “modest” tightening of monetary policy is now appropriate to return inflation to target and keep it there, while he emphasized that further rate increases will be limited and gradual. He also noted that “Policy needs to walk – not run – to stand still” and reminded us that the Bank is working on the assumption of a relatively “smooth Brexit”.
In our view, the pound may have tumbled as Carney’s remarks were interpreted as somewhat more cautious than the vote result suggested. It could also be that with all the uncertainty surrounding Brexit, market participants are losing their faith over a smooth divorce and thus, the fact that the Bank is working on a “smooth Brexit” basis makes it hard for them to expect a more hawkish Bank at its upcoming gatherings.
In an interview for BBC after his policy press conference, the Governor said that market pricing for a hike per year for the next few years is a good rule of thumb, but with the caveat that it will depend on what happens with Brexit. Thus, with the Bank probably done for this year, we expect pound traders to turn their attention back to politics and developments surrounding the UK’s departure from the EU. The two sides are expected to return to the negotiating table in mid-August after taking a short summer break. With the clock ticking towards the 29th of March 2019, the official date of the EU-UK divorce, further delays to find common ground could increase investors anxiety and could keep the pound under selling pressure.
GBP/JPY continued to climb higher in the first half of the week and it looked like it could be smooth sailing from there. But on Thursday, Mark Carney’s press conference changed everything, and all the week’s gains were wiped out. The pair closed the day with approximately a 120-pip loss. GBP/JPY remains below its medium-term downside resistance line, taken from the peak of the 2nd of February. But at the same time, the pair is still above the short-term upside support line, drawn from the low of the 29th of May. That said, if strong selling kicks in again, then the upside support line could easily get broken.
For now, we remain bearish for the short-term outlook, as we could see a follow up move lower today, especially if GBP/JPY breaks the 145.20 support level, near yesterday’s low. The next stop for the pair could be the aforementioned upside support line and the 144.30 support zone, marked by the low of the 29th of June. This could be the zone which could stall the rate initially, but if it does not hold, more bears could join in and we could see a continuation move lower towards the 143.75 level, which was the low of the 28th of June. Slightly below that lies the lowest point of May at around the 143.20 level that could be a strong hold for GBP/JPY from dropping further.
Also, we should not exclude the possibility of GBP/JPY getting a bit of retracement back to the upside, where the bears could take advantage of that and pull the pair down again, towards previously discussed levels.
Alternatively, if GBP/JPY makes a full recovery of this week’s losses and breaks its weekly high at around the 147.15 zone, we could then start positioning ourselves for some higher levels. The next good area of resistance could be seen at 147.60, which was near the high of the 19th of July. Further acceleration of the rate could lead to a test of the 148.25 level, marked by the high of the 18th July. A break of that zone could set the stage for the 149.30 barrier, which was near the highest point of July, but slightly above that runs the aforementioned downside resistance line, which could stop the rate from rising further.
The dollar traded higher against all but one of the other G10 currencies on Thursday. It gained the most against SEK, NZD, NOK and GBP, while it traded virtually unchanged against CAD.
Today, the spotlight is likely to fall on the US employment report for July. Expectations are for non-farm payrolls to have increased 193k, after rising 213k in June. The unemployment is expected to have declined to 3.9% from 4.0%, while average hourly earnings are anticipated to have accelerated somewhat, to +0.3% mom from +0.2%. Without any revisions to the prior monthly prints, this would keep the yoy earnings rate unchanged at +2.7%, as the monthly print of July 2017 that will drop out of the yearly calculation was also +0.3%.
Even though the initial market reaction may come from the NFP number, barring any major deviation from the forecast, the aftermath direction is likely to be dictated by wage growth. An upside surprise in wages could be translated to more spending and hence, accelerating inflation in the future. Following Wednesday’s FOMC decision, when the Committee kept the door wide open for two more hikes this year, this could strengthen further the case. According to the Fed Funds futures, the market now implies a 94% probability for the next hike to occur in September, while there is around a 70% chance for another one to come in December. On the other hand, a modest slide in the yoy earnings print could weigh somewhat on the probability for the Fed to end the year with 4-hikes, but we doubt that it would be enough to drive it well down. In our view, we need to see a notable decline in the earnings rate in order for the 4-hike probability to drop below 50%.
As for the dollar, it could strengthen on a strong report, even if wage growth remains unchanged, but not much. The market has already priced in the 4-hike case to a large extend. Now, in case wages surprise to the downside, the greenback could give back some of its recent gains, but a big disappointment is needed, we believe, for the currency to fall off the cliff.
USD/CAD continues to drift south towards the medium-term upside support line, drawn from the low of the 2st of February. The pair is also trading below its short-term downside resistance line, taken from the peak of the 27th of June. That said, although the medium-term trend remains to the upside, in the short run, we believe that there could be more selling coming in before the bulls decide to take charge again.
The pair found good support this week near the 1.2975 level, but if tested again and then broken, this could open the door towards the 1.2950 area, marked by the low of the 14th of June. Slightly below that lies the abovementioned medium-term upside support line, which could act as a good bouncing ground for the pair, which could move back up again towards some key areas of resistance initially, and then towards the previously mentioned downside resistance line. The first good area of resistance to watch is the 1.3040 hurdle that held the rate down yesterday. If it gets broken this time, then this could open the way for a test of the area between 1.3095 and 1.3110, where the first level acted as the high of the 31st of July and the second was a strong support, seen between the 16th and the 23rd of July. A move above that could set the stage for a test of the 1.3190 barrier, marked by the high of the 24th of July.
On the other hand, if the medium-term upside support line gets broken, this is where it could turn out ugly for USD/CAD, as such a break may invite more bears into the action. The move could open the path to the next potential area of support at 1.2855, marked by the low of the 6th of June. Below that lies another good potential support zone at the 1.2815 level, which held the rate from dropping lower on the 31st of May.
During the European morning, we get the final services and composite PMIs for July from the nations of which we got the manufacturing prints on Wednesday. Once again, the final prints are anticipated to confirm the preliminary estimates. Eurozone’s retail sales for June and the UK services PMI for July are also coming out.
From the US, besides the employment data, we get final services and composite PMIs for July, as well as the ISM non-manufacturing index for the month. From Canada, we have the trade balance for June.
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