The pound fell off the cliff yesterday as UK politicians, including the new PM Boris Johnson, ramped up rhetoric over a no-deal Brexit, prompting investors to increase bets with regards to such an outcome. In Japan, the BoJ kept its policy and forward guidance unchanged, noting that it “will not hesitate to take additional easing measures”. Market attention may now fall to the new round of US-China trade negotiations, which ends tomorrow.
The pound collapsed against all the other G10 currencies yesterday. It tumbled the most against NOK, CHF and EUR, while the currencies that eked out the least gains against their British counterpart were JPY and AUD.
What prompted market participants to start selling pounds was once again developments surrounding the UK political landscape, and especially Brexit. The first hit came by Michael Gove, the man in charge of no-deal preparations, who said that the government is working on the assumption that the EU may not be willing to strike a new deal with the UK. Although indeed the EU’s position remains that the accord agreed with the former PM Theresa May is not up for negotiation, Gove’s remarks suggested that the government may be considering a disorderly exit as the most likely outcome.
The no-deal rhetoric was ramped up by Foreign Secretary Dominic Raab, who said that they are “turbo-charging” their preparations with regards to exiting with no accord, adding that the “undemocratic” backstop must be dropped from the Withdrawal Agreement. He also said that they want a deal, but if the EU continues to be “stubborn”, they must be prepared for a no-deal exit. Raab’s remarks were echoed by Boris Johnson later in the day, although the Prime Minister rejected the claim that no-deal is the base-case scenario.
As for our view, we stick to our guns that the rising chances of a chaotic exit on October 31st are likely to keep the pound in a downtrend. Even if someone argues that yesterday’s collapse to a 28-month low (against USD) means that the no-deal outcome may be priced in to a large extend, we believe that the worst is not behind us yet and that the pound still has room to move lower. Yes, the overstretched freefall may eventually result in a rebound due to short covering, but we expect any recovery to stay limited and short-lived. Apart from the increasing bets over a no-deal Brexit, there is also speculation that the BoE may eventually abandon its hiking plans, which heading into Thursday’s meeting could keep the pound pressured. What’s more, having in mind that the popularity of the Conservative Party has risen according to opinion polls, we see increasing chances for Johnson to call parliamentary elections, as a victory may allow him to weaken lawmakers' opposition to a no-deal Brexit.
The British pound took a hard hit yesterday, when it fell against all of its major counterparts. One of the biggest declines was against the euro. Looking at the EUR/GBP chart, you can see the steep move, which doesn’t seem to stop. At the time of writing this analysis, the pair is trying to make its way to the 0.9203 barrier, marked by the high of September 8th, 2017. We will continue targeting slightly higher areas, at least for a short-while more.
As mentioned above, a further move higher might bring EUR/GBP to a test of the 0.9203 zone, which could provide some initial resistance. If the rate stalls around there and struggles to make its way above that barrier, we may see a small correction back down. But if EUR/GBP stays above the 0.9149 hurdle, marked by the inside swing low of September 1st, 2017, this might attract the buyers again and send the pair back up. This is when we will target the 0.92030 obstacle again, a break of which would confirm another higher high and could push the rate to the 0.9230 area, or even to the 0.9270 level, marked by the high of August 30th, 2017.
Alternatively, a drop below the 0.9110 hurdle, which, up until yesterday, was the highest point of 2019, could open the door for a decent downside correction. We will then examine a possibility of seeing a slide to the 0.9051 obstacle, which is the high of July 17th, a break of which could increase the pair’s chances to continue moving in the southern direction, aiming for the psychological 0.9000 level, marked by the high of July 22nd.
Flying from the UK to Japan, overnight, the BoJ concluded its two-day policy meeting, where officials decided once again to keep their ultra-loose policy unchanged via a 7-2 vote, and maintained the forward guidance that the current extremely low levels of interest rates are likely to stay unchanged “at least through around spring 2020”. The Bank added that it “will not hesitate to take additional easing measures if there is a greater possibility that the momentum toward achieving the price stability target will be lost”, and largely downgraded its GDP and inflation forecasts. The yen strengthened around 10 pips (against USD) at the time of the release, perhaps as the outcome was not as dovish as many may have expected. Although reports over a divided Board weakened the case of fresh stimulus at this gathering, many participants (including us) may have expected officials to ease their forward guidance.
Now, JPY-traders could turn their attention to developments surrounding the broader market sentiment, and especially the new round of US-China talks, which is expected to last until tomorrow. Last week, US Treasury Secretary Steven Mnuchin said that more talks will follow as “there’s a lot of issues” to be worked out, while on Friday, US President Trump said that he thinks China may not want to seal a deal before the 2020 election as it may have the opportunity to negotiate more favorable terms with a new President. With all these in mind, we see the case of the two sides agreeing to a final accord this week as a hard task. However, any progress signs and remarks could be very welcome by the financial community, which, in the aftermath of the Trump-Xi meeting, stood skeptical as to whether the world’s two largest economies will indeed make concrete steps towards solving their differences.
Equities and risk assets are likely to gain, while safe havens, like the yen, may come under pressure. In the past we noted that AUD/JPY was one of our favorite proxies for gauging changes in the broader market sentiment, but this time, we would expect any potential rebound to be limited and short-lived, even if global equities continue trending north. It seems that the correlation between the pair and stock indices has fallen and, in our view, this is because equities have been on the front foot lately due to expectations of easing in the global monetary-policy arena, with the RBA being no exception. The Australian central bank has already cut rates twice, in June and July, and may continue with more decreases. On the other side of the equation, the BoJ may have limited ammunition left for ramping up stimulus. Thus, with investors paying more attention to monetary policy, AUD/JPY could come back under selling interest, at least in the short run, even if it rebounds on potentially optimistic trade remarks.
AUD/JPY continues to slowly grind lower. After breaking through the lower side of the range, where it was trading in from end of June, the pair seems to be showing signs that it could drift further south. To remind our readers, the above-mentioned range was roughly between the 75.19 and 76.28 levels. We can see that yesterday, the rate tried to climb back above the 75.19 barrier but failed to do so and the bears quickly pushed it to the downside. Now AUD/JPY is balancing slightly above the 74.89 support area, but if it gets broken, this may clear the path to further declines, hence why we will stay somewhat bearish, at least in the short run.
As mentioned above, a break of the 74.89 support zone, marked by yesterday’s low, would confirm a forthcoming lower low and the rate may slide to the 74.70 hurdle. That hurdle marks the intraday swing high of June 25th. If that area is not able to withstand the bear pressure, a rate-drop below it could send AUD/JPY further down, potentially targeting the 74.32 level. That level marks the low of June 25th.
On the upside, if by any chance the bulls are capable to push the rate back inside the previously-mentioned range, above the 75.19 barrier, or even above the 75.25 mark, which is the low of July 25th, we will shift our view to a more neutral one. Such a move could send the pair higher within that range, where we could aim for the 75.58 obstacle, marked by the high of July 25th. If that obstacle is seen just as a temporary pit-stop for the bulls to refuel, a break of it could lift AUD/JPY to the 75.81 level, which is the low of July 21st and the intraday swing high of July 23rd.
During the European morning, Sweden’s GDP for Q2 is scheduled to be released and the forecast suggests that the yoy rate declined to +1.9% from +2.1% in Q1. That said, this would be just a tick above the Riksbank’s projection for the year, which is at +1.8%, and may allow Swedish officials to keep the door open for a hike towards the end of the year. That said, the next Riksbank meeting is scheduled for September 5th, and ahead of that we have several data points that could alter policymakers’ view. The dovish stance by the ECB last week may be another factor to take into account, as the Riksbank has been following the ECB’s footsteps in recent years.
From Germany, we have preliminary inflation data for July. Expectations are for both the CPI and HICP rates to have declined to +1.5% yoy and +1.3% yoy, from +1.6% and +1.5% respectively, which may raise speculation that Eurozone’s headline inflation, due out on Wednesday, may also slow.
In the US, we get personal income and spending data for June, alongside the yoy core PCE rate for the month. Both income and spending are expected to have slowed, to +0.4% mom and +0.3% mom, from +0.5% and +0.4% respectively, while the core PCE index is expected to have remained unchanged at +1.6% yoy. However, bearing in mind that the core CPI rate for the month ticked up, we see the case for a similar move in the PCE as well. The Conference Board consumer confidence index for July, as well as pending home sales for June are also due to be released.
As for tonight, during the Asian morning Wednesday, we get Australia’s CPIs for Q2. The headline rate is forecast to have risen to +1.5% yoy from +1.3%, while the trimmed mean rate is anticipated to have ticked down to +1.5% yoy from +1.6%. Although expected to rise, a +1.5% yoy headline rate would still be below the Bank’s latest forecast for June, which is at 1.75%, while the trimmed mean rate would match its respective projection.
Therefore, if the forecasts are met, we see it unlikely of market expectations around the RBA’s future plans to change much. Following the soft employment report for June and recent remarks by Governor Lowe that the Bank stands ready to ease further in order to make sure inflation returns to the 2-3% target range, investors have nearly factored in the next cut to come in October. We believe that for that timing to come forth, the CPIs would have to disappoint.
China’s manufacturing and non-manufacturing PMIs for July are also on the Asian agenda. The manufacturing index is expected to have risen to 49.6 from 49.4, while the non-manufacturing one is expected to have slid to 54.0 from 54.2.
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