As far as the eurozone is concerned, there have been some bright spots economically. Survey data in recent weeks has pointed to the start of a recovery. The eurozone economy is still contracting and there is still not much to cheer about at this stage but the pace of contraction is slowing and hopes of a recovery in the second half of 2013 are now very realistic. However, economic improvements have been offset by the re-emergence of debt crisis fault lines. Greece is back in the headlines for all the wrong reasons, while the political situation in Portugal in particular has pushed up bond yields and highlighted the euro’s ongoing vulnerability to political instability.
The dollar has endured a rocky time of it in recent weeks but the clarification that Ben Bernanke gave at the last US Federal Reserve meeting looks to have been a key moment. For a long time now the market has been second-guessing the Fed’s position on tapering its QE3 programme and on June 19, Bernanke communicated in no uncertain terms that they are on course to begin tapering later this year. Underpinning all of this, US data was broadly encouraging through June and things have started well this month with an excellent monthly employment update. Accordingly, we remain comfortable with our bullish USD position.
GBP/EUR
Downside risks prominent in light of BoE concerns
UK growth data remains on an uptrend but we, like many others, have been continuously frustrated to see the pound underperform its economic fundamentals on the exchange rates. This is particularly the case with respect to the euro.
Taking a look at UK conditions then, we have seen improvements in almost all areas of the economy. Judging by the monthly PMI surveys, the UK manufacturing and construction sectors have recovered by spending the past two months in expansion territory, while the dominant UK services sector continues to kick on impressively. UK services sector growth actually hit more than a two-year high in June.
Confidence in the private sector really is picking up and there are other areas to be cheery about too. Data revealed that UK retail sales for May surged by 2.1%, while we saw yet more improvement within the UK labour market. Meanwhile, the latest Bank of England credit report pointed to improvements in lending in Q2 to both individuals and corporate entities.
What has been slightly more disappointing on the growth front has been the news that on an annual basis, GDP has been downgraded from 0.6% to 0.3%. Nonetheless, Q1’s 0.3% GDP figure was confirmed and looking at the present and future (which is far more relevant than what went on last year), activity is looking up. Glancing ahead to the July 25 preliminary Q2 UK GDP figure, we are expecting at least a 0.5% showing, with a considerable chance of an overshoot. Given the sort of GDP figures coming out of the eurozone, we feel justified with our calls for a higher GBP/EUR rate, though we will seemingly have to be very patient.
So what is the Bank of England’s take on UK conditions? Carney didn’t take long to cause a stir, getting started by releasing a statement which managed market expectations surrounding monetary policy. Carney has told us that interest rates will remain lower for longer (probably unchanged at record lows into 2016) and the market has interpreted an increased chance of further quantitative easing down the line. The MPC statement was also distinctly cautious despite the upturn in recent UK growth data, reminding us that growth “remains weak by historical standards.” An MPC statement in itself is actually very unusual; the last one was released in March 2009, so the market is clearly concerned that Carney is planning an aggressive shake-up on the monetary policy front. Based on a steadily improving economic performance and brightened outlook, we feel that the Bank of England will not elect to top up its asset purchase facility (quantitative easing) next month but we cannot rule it out later this year given Mark Carney’s aggressive entrance. Concerns in this regard will weigh on GBP.
Euro typically robust despite political concerns
While the UK recovery makes strides, the eurozone recession also appears to be stabilising. Looking at the eurozone PMI figures as a whole, a 15-month high was hit. This is encouraging stuff, though the PMI gauges do still remain in contraction territory. With this in mind, we do not expect the European Central Bank to cut interest rates again soon, particularly in light of the recent upturn in eurozone price pressures. Draghi did however remind us in his recent press conference that another rate cut is still very much on the table. In terms of other monetary policy measures, talk of negative deposit rates is probably aimed at easing the pressures being felt in the peripheral bond markets. Again, we would be surprised to see them implemented soon.
Events in Greece are definitely ramping up debt crisis nerves – the last thing the market wants to see is a return to the brink for that troubled country. Greece is currently grappling with officials over the release of the next €8.1bn bailout tranche, regarding which eurozone finance ministers will be meeting on Monday July 8.
Greece needs to show that it has made sufficient progress on reforming it public sector and it looks as though a deal will be struck with IMF to avoid the body withdrawing its support for the bailout plan. There is real sense that Greece is not doing enough and developments could well weigh on the euro in the short-term.
Portugal is the other dominant concern as far as the euro is concerned at present; the political situation there has been in turmoil after the recent resignation of the finance minister, followed by the leader of the junior coalition partner/foreign minister. Despite recent news that a deal has been struck to keep the governing coalition intact, there remains a risk that the government could fall apart and early elections be called, which would raise uncertainties surrounding Portugal’s commitments to its bailout plans. The political climate is likely to remain highly fragile in the weeks and months ahead. So long as unemployment soars, political risks are likely to be the centrepiece of the debt crisis moving forward, throughout the eurozone.
After this week’s major GBP/EUR downswing, which saw fresh 3 ½ month lows posted below €1.16, we can no longer ignore the downside risks that this pair is likely to face over the coming weeks. We certainly don’t believe the fundamentals justify this sort of GBP/EUR weakness but momentum counts for quite a lot in FX. We do see this pair recovering later on in the year but for now, levels below €1.16 look set to dominate.
GBP/USD
Confirmation of QE3 tapering frees up dollar rally
GBP/USD’s rise in June up to four-month highs in the $1.5750 area was, at least in part, a fair reflection of this improved UK growth performance and brighter outlook (though it would more accurately be attributed to doubts over QE3 tapering). However, the rate has fallen every bit as far and fast as it climbed and we don’t expect to see those levels again given the intentions stated by the Fed last month.
There is no shortage of dovish dissent from within the US Federal Reserve but Chairman Ben Bernanke has clearly been sufficiently encouraged by US growth data to communicate to the market that an exit plan for QE3 is loosely in place and that they are on schedule to taper it off in H2 of this year. This did not come as a surprise to us but the verbalisation of these intentions from the man himself appears to have been a seminal moment. Stocks, commodities and other riskier assets suffered and funds came flooding back in the greenback.
We retain a broadly positive outlook for the US economy across the second half of the year. The eurozone recession does appear to be stabilising now and is likely continue to do so but improvements will be very slow indeed and the bloc is streets behind its US counterpart, which supports are calls for a lower EUR/USD pair. EUR/USD is still a fair way off its year-to-date lows of $1.2745 and we fully expect this to be targeted in the weeks ahead. GBP/USD will be hard-pushed to post anything but further losses below $1.50 if this scenario plays out.
A stronger US economy, as shown by the recent strong US non-farm payroll figure, should result in the Fed tapering QE3 and in doing so support the dollar in the coming months. We do feel the lingering concerns over further BoE QE are slightly overstated but this is unlikely to be sufficient for sterling to avoid another decline vis-a-vis the dollar.
On top of monetary policy and growth drivers, we are seeing a considerable slowdown in Chinese growth, which as well as weighing on commodity prices and confidence in the global recovery, is seeing cash flood out of the emerging markets. This again is a safe-haven, dollar-positive theme.
Exchanging currency
With some crucial support levels having been taken out, GBP/USD looks set to head even lower. Targets towards $1.40 by the end of the year remain very realistic.
GBP/EUR: €1.1550
GBP/USD: $1.47
EUR/USD: $1.2725
Richard Driver
Foreign Exchange Analyst
Caxton FX
- This post has been prepared by Caxton FX Ltd for information purposes only
- If you would like more information or would like to make a money transfer, get in touch info@caxtonfx.com.
