Governor Carney fails to convince the market

Today the Bank of England published its latest Inflation Report which was perceived to be broadly positive as the central bank raised its forecasts for UK growth. In his opening remarks, the Governor said the recovery is not yet sustainable and outlined in forward guidance that the central bank will not raise interest rates until more spare capacity has been absorbed. Other broader measures will also be looked at when considering whether to tighten policy, including the unemployment rate. There was also emphasis on the lack of business investment growth and even when the bank does raise interest rates, the process was described to be limited and gradual as the economy still faces a number of headwinds.

Although the Inflation Report does not lay out a timeline for when interest rates will rise, the market has taken the bullish growth projections as a signal that tightening in Q2 2015 is likely. Lack of productivity has been a key issue for the central bank and they have become even more pessimistic about the outlook. Taking this in account, it is surprising that this hasn’t pushed back market expectations of monetary policy tightening.

Considering the fact that the unemployment rate dropped significantly faster than the BoE predicted, it is no surprise that the market is drawing its own conclusions. Until the central bank is successful in reiterating their commitment to low interest rates, sterling bulls will keep demand for the pound strong.

Sasha Nugent

Currency Analyst

Caxton FX

January 2014 Currency Report: Sterling regroups in a bid to maintain momentum

Sterling momentum strengthened last month after strong employment data encouraged sterling buyers to resurface. The pound managed to get the upper hand on the euro, whilst the dollar struggled to drive the GBP/USD rate downwards, despite the Fed’s tapering decision. As we enter the New Year, the same factors will influence the pound’s strength and the debate about when the BoE could raise interest rates will continue. The market’s eye will remain fixed on the improvements in the labour market as well as price pressures.

There are still plenty of questions regarding the eurozone, and although the region is showing signs of progress, the issue of deflation and a buoyant euro remains. The ECB have maintained their dovish stance in the last few months and have reiterated their commitment to price stability, claiming the central bank have various tools to combat low inflation. We are yet to know what these tools are, and going in to January, the market will be paying close attention to any language from the ECB which may shed some light on the central bank’s ammunition.
As we approach the next US debt ceiling, some of the pressure on the government has faded amid the agreement in spending levels reached by Democratic and Republican negotiators. Although this agreement avoids a shutdown occurring this month it has not yet been passed through congress and does not increase the US debt limit, leaving the potential for budget crisis still open. Tapering has finally begun, with the Federal
Reserve trimming $10bn from asset purchases reducing the total to $75bn a month. The Fed has managed to convince the market that tapering is not tightening and updated their forward guidance claiming that interest rates will remain low even after the unemployment rate has reached 6.5%.

The year begins on a positive note

With UK economic data still impressing, this month the market is looking for signs to help gauge how sustainable the recovery is. The outlook for the nation is pretty much unchanged and although the last inflation reading showed inflation fell closer to the BoE’s 2% y/y target, there is still a possibility we could see a rate increase in 2015. We know from the latest inflation report, that slack in the economy needs to be absorbed and business investment needs to pick up. The market seems to have pushed these details to the side for the time being and focus remains on the labour market as well as price pressures. As a result, we doubt things will be much different from last month. Language used by the monetary policy committee will be monitored carefully. Last month we witnessed a sterling sell off after comments from BoE member Weale suggested the central bank will maintain loose monetary policy even after the 7% unemployment threshold has been reached. This triggered sterling weakness and if more dovish language is expressed by the BoE we doubt the market will hesitate when unwinding sterling long positions. It will be a difficult month ahead for sterling. With tapering talk limiting potential gains against the dollar and euro investors still preventing the pound from holding on to levels above 1.20, a lot more is needed to get sterling to make any meaningful rebound.

GBP/EUR

Euro pressure eases a little

Towards the end of December we saw euro strength re- emerge and combined with lower UK inflation force the rate from levels above 1.21 back towards 1.18. After the ECB’s last rate cut, eurozone inflation rose to 0.9% y/y, providing the euro with some short-term relief. The ECB’s lack of concern about the currency’s strength encouraged the market to continue to support the euro, and it is unlikely that we will see any change in the ECB’s attitude towards the exchange rate this month. Whilst they have made it clear that targeting the exchange rate is not an option, they have withheld details about what tools are available to combat low inflation. In a number of press conferences and speeches ECB President Draghi has said that the bank expects inflation to remain low for a prolonged period and if downside risks materialise, the bank is ready to take action. There have been whispers that negative deposit rates may be one of the many weapons the ECB has at their disposal, and this month we may get more of an idea about what the central bank has in store. The prospect of another round of cheap loans for European banks may also creep back into focus. The market believes another round of LTROs is on the table, however the central bank are yet to provide any clarity on the likelihood of this happening any time soon. Investors will be listening attentively to ECB members’ comments for clues on the next likely move from the ECB.

There are signs that sterling’s strength has become more sustainable and so we expect the pound to

recover.

GBP/USD

We begin the new year with $10bn less stimulus

There is plenty going on in the US this month to keep volatility in the GBP/USD rate alive. Instead of buying $85bn worth of assets, the Federal Reserve will purchase $75bn in an attempt to wind down the quantitative easing program. The reaction was fairly muted as the central bank managed to convince the market that a reduction in stimulus is not a tightening of policy. The central bank also adjusted its forward guidance, stating that loose monetary policy will remain even after the unemployment rate has reached 6.5%.

Ben Bernanke’s term as Chairman of the Federal Reserve will come to an end this month, paving the way for Janet Yellen to take up the post. Despite Yellen being considered a dove, she supported the move to kick start tapering this month and this suggests she may be less dovish than previously thought. She obtained the Senate’s approval (56-26) to become the first female Chief in the Fed’s 100 year history in last night’s vote.

The issue regarding the US debt ceiling will resurface this month, however, with Republican and Democratic negotiators reaching a deal on spending levels, the risk of a government default has diminished. The deal which is small in size should prevent a shutdown this month if it is approved by Congress, but new borrowings will also have to be passed if a budget crisis is to be avoided.

GBP/EUR: 1.2130
GBP/USD: 1.6280
EUR/USD: 1.3420 

What is more important? Rate increases or price stability?

It has now become common knowledge that the UK recovery is taking hold, and the next hurdle for the economy is to ensure this recovery can be sustained. The BoE have outlined in their forward guidance, that unless any of the thresholds are breached, they will maintain their current dovish stance, and re-evaluate policy once the unemployment rate has reached 7%.

Since the introduction of forward guidance, the markets have had their eye on the inflation and unemployment rate looking for signs to gauge the BoE’s next policy move. The labour market has improved faster than projected and inflation has also eased more quickly towards the BoE’s target of 2%y/y. In situations where unemployment figures surprised the market to the upside, demand for sterling increased, strengthening the pound. When lower inflation numbers have been revealed, sterling has taken a hit, as this dampened investor’s expectations of a rate increase in 2015.

Despite criticism, it is looking more like the central bank will not be forced to raise interest rates. Loose monetary policy has helped to support the recovery which continues to gain traction, all whilst price pressures have eased, now only 0.1% away from the target. Domestic demand is likely to strengthen, resulting in an upward pressure on inflation, but for the time being the BoE now has more room to maintain a policy which seems to be working.

A few months ago the market believed that inflation would remain above target forcing the central bank to take action and raise interest rates. With inflation easing, the BoE is no longer under pressure to do so, and the market seems to be forgetting that despite the dampened expectations of a rate hike, inflation that is in line with the central bank’s target is a good thing. Yesterday CPI unexpectedly came in below expected at 2.1%y/y and this immediately resulted in sterling weakness. What we saw was the pound being penalised for inflation trending towards the central bank’s target.

Sasha Nugent

Currency Analyst

Caxton FX

Bank of Canada deals the loonie a blow

The Bank of Canada is ahead of almost every other developed nation central bank in terms of when it expects to normalise monetary policy (raise interest rates). The fact that it is even discussing it is your first clue, as conversations within central banks such as the Bank of England, Reserve Bank of Australia, the European Central Bank and the Riskbank are slanted towards rate cuts, not rate hikes. If it’s not rate cuts, then it’s more QE from the likes of the US Federal Reserve and the Bank of Japan, whose base rates are already at rock bottom levels.

Last year’s Bank of Canada rhetoric pointed towards a rate hike this year. However, the slowdown seen in the US at the end of 2012 has contributed to softer growth in its northern neighbour. Canadian growth has consistently surprised the BoC to the downside in the past year, particularly in the second half of 2012. Governor Carney (BoE-bound this summer) & Co yesterday indicated that the Canadian economy will not be up to full capacity until the second half of next year, which is a major delay compared to the previous ‘late 2013’ projection. Combined with subdued inflation and ongoing concerns over household imbalances, this has led the BoC to communicate that a rate hike is by no means imminent. It estimates a rate hike at the end of this year but our bet is that it will come a later than that.

The loonie has taken a hit as a result of the BoC’s change of position. GBP/CAD climbed by more than a cent and a half up to 1.5850, where it currently trades. Meanwhile CAD/USD dipped by a cent to a level just below parity, which represents a two-month low. This is a bit of a knock to the loonie but we do expect the currency to outperform GBP in the coming months, with another move down to 1.55 very much on the cards. 

Richard Driver

Currency Analyst

Caxton FX

Swedish Krona March Outlook

The Swedish krona and other risky currencies finished 2011 strongly and made an impressive start to 2012. Risk appetite has been spurred on by the ongoing impact of the European Central Bank’s (ECB) mid-December LTRO (cheap loan offering), further improvements to the US economic recovery and the emergence of a Greek bailout agreement.

However, huge uncertainties surround both the Greek and wider eurozone debt situation. In addition, data this year clearly points to the onset of a recession in the euro-area. The risks to a downturn in market sentiment, which will inevitably weigh on the krona, are all too apparent.

In terms of the Swedish economy, growth has deteriorated and the prospects for this year have weakened. Amid diminishing internal and external demand and rising unemployment, the Swedish economy contracted by 1.1% in the final quarter of 2012. Accordingly, the Riksbank is forecasting growth of just 0.7% for 2012.

The Riksbank cut the Swedish interest rate by 25 basis points to 1.50% in February, following the rate cut we saw in December. Further monetary easing this year cannot be discounted if conditions continue to worsen. In addition, after an impressive surplus last year, the Swedish National Debt Office has recently announced that it expects a budget deficit of 11bn krona this year.

We hold a pessimistic view for Greek and eurozone developments this year, on both the growth and the debt front. This should weigh on risk appetite and combined with the Swedish economy’s downtrend, the outlook for the Swedish krona is decidedly vulnerable.

GBP/SEK

Interest rate developments have gone against the Swedish krona in recent months, with the Riskbank reducing its yield from 2.00% to 1.50%. The moves were down to both diminishing global and domestic growth. With the eurozone accounting for more than half of Swedish exports, the recession that the region is heading into is likely to weaken Swedish growth to an even greater degree. The Swedish inflation outlook is also distinctly tame, so there is little scope for a Riksbank rate hike this year, while a further cut will certainly be considered if conditions both internally and externally deteriorate.  

This Swedish downturn contrasts with the good news that has emanated from the UK economy in the past few weeks. UK retail sales figures have been excellent; the services sector continues to show decent growth and the construction sector also bounced back in February. These firmer figures have made a return to positive growth (after last quarter’s -0.2% GDP figure) highly likely in Q1 2012. This in turn should dissuade the MPC from deciding on further UK quantitative easing this year. It also increases the likelihood of the UK hanging onto its prized AAA credit rating, which is a major pillar of support for sterling.

The ECB’s cheap loans have fuelled a rally in risky assets in the past three months, as shown by the FTSE 100’s recent climb to a seven month high. However, an improved outlook for the UK economy (and therefore sterling), a deteriorating Swedish economy and a fairly sharp decline in risk appetite have seen GBP/SEK show signs of resuming last year’s uptrend. In line with a pessimistic view towards the overall eurozone situation, we see GBP/SEK consolidating on its recent bounce in the 10.7-10.8 area over the next few weeks. In the medium and longer-term, the risks are skewed towards a further upside move towards 11.00.

EUR/SEK

There have been some positive developments in the eurozone in recent months. The ECB’s cheap loans have ensured that credit conditions in Europe have eased this year and have fuelled a rally in eurozone equities and brought key peripheral bond yields in Italy and Spain down to more sustainable levels. A long-awaited Greek bailout agreement finally arrived in February, quelling fears of a messy Greek default in mid-March (albeit temporarily).

However, the market also remains incredibly tense about the Greek situation. A Greek bailout is by no means assured, which means we may yet see a messy Greek default this month. Greece has until the evening of Thursday 8^th March to convince enough private bondholders to sign up to the debt-swap arrangement, failure to do so could result in a credit event in which credit default swaps are triggered.

The potential Greek scenarios that are currently on the table are many and varied and this lack of certainty is what is weighing on risk appetite at present. Even in a best case scenario in which Greece gets its second bailout and avoids a default without triggering a credit event, there are strong arguments that suggest this is simply an exercise in buying time and we could be back in bailout and default territory before long.

In addition, eurozone growth remains a key concern. The region contracted by 0.3% in the fourth quarter of 2011 and judging by growth figures out of Germany and the region as a whole, a slide back into a prolonged recession is now looking somewhat inevitable.

By virtue of the Swedish krona’s negative correlation with low levels of risk appetite and in line with our view that we are entering a period of damper market confidence in which safer assets than the krona will be turned to, we are confident that EUR/SEK will continue to climb. We have seen a sharp spike from 8.80 to over 8.90 in the past week and we are looking for a push towards 9.00 in March.

USD/SEK

To buck the global trend of weakening global growth, the US recovery has really gathered pace in recent months. The US economy grew at an impressive annualised pace of 3.0% in the fourth quarter of last year and there have been significant improvements to America’s chronic unemployment problem. This upturn seems to have caused US Federal Reserve Chairman (Ben Bernanke) to indicate that QE3 will not be utilised, which is a real positive for the US dollar.

By contrast, the US dollar made a very weak start to 2012 but we believe the greenback will be a major outperformer this year. With intervention doubts surrounding the other traditional safe-haven currencies (the yen and the swiss franc) and with the EUR/USD pairing looking increasingly vulnerable to a collapse, the USD is set for major gains in what will surely be a highly uncertain, dollar-friendly environment this year.

The bounce in the USD/SEK rate (from 6.55 to 6.80) in the past week should represent the start of a major reversal of dollar weakness. We see the USD strengthening in excess of 7.00 krona level in coming months, though over the next few weeks gains will probably be limited by the 6.90 level.  

NOK/SEK

The Norwegian krone has made an extremely impressive start to 2012. It is the top performing currency over the past month thanks to a combination of domestic economic strength and soaring oil prices.  Norwegian manufacturing and retail sector growth and declining unemployment has improved sentiment towards the NOK, while a widening trade surplus shows that exports are not being hit as they are in neighbouring Sweden.  The Norwegian economy outperformed the Swedish economy in the fourth quarter of 2011 by growing 0.6% (versus Sweden’s 1.1% contraction) and is almost certain to continue outshining this year.

Oil prices have risen by 15% already in 2012 amid worrying developments in Iran; Brent crude is currently trading just off a multi-month high above $125 per barrel.  As a major producer of oil, the Norwegian economy stands to benefit and so too does its currency.

The only real question mark hanging over the Norwegian krone is the monetary policy of the Norges Bank. The state of Norwegian economic growth wouldn’t suggest another cut to the Norwegian base rate, which currently stands at 1.75% (slightly higher than the Swedish 1.50% rate). However, Governor Olsen has reiterated that the Norges Bank will consider the strength of the krone when evaluating its interest rate policy. Another rate cut may well come if the NOK continues to appreciate but the krone is likely to remain in demand regardless.

With the NOK/SEK rate having bounced from just above 1.14 to just below 1.20, the Norwegian krone is the clear outperformer here. NOK/SEK is actually trading only marginally below a 25-month high. However, the current pace of appreciation is unlikely to persist for another month as Norges Bank intervention concerns will inevitably temper progress. Still, we should not see too much of a downward correction away from the current 1.20 trading level.

Caxton FX Morning Report

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It was a fairly calm start to the week yesterday, with no data of any major significance and little new information for the markets to digest from the weekend. Rating agency Standard & Poor’s downgraded Greece to the level of “selective default” but the markets were unperturbed, needing no reminder of how serious matters have become there.


Today’s session should be a little more lively; we have a UK CBI realised sales figure released this morning, followed by some durable goods orders and consumer confidence figures out of the US.

STERLING/EURO: This pair traded pretty flat ahead of tomorrow’s cheap loan offering from the European Central Bank.  

STERLING/US DOLLAR: After fading a little yesterday, this pair is back in pursuit of $1.59, which it should achieve this week.

EURO/US DOLLAR: A fairly tame attempt was made at $1.35 but you can expect this level to be given a sterner test.

STERLING/AUSTRALIAN DOLLAR: This pair was once again on the back foot having reached the top of its 2012 trading range.

STERLING/NEW ZEALAND DOLLAR: Sterling also retraced back down below 1.90 thanks to decent risk appetite in US trading.

STERLING/CANADIAN DOLLAR: After a strong week last week, this pair has fallen off by more than a cent from its 2012 highs.

Strong UK retail sales perfromance triggers hope of positive Q1 growth

January’s growth figure for UK retail sales came in at 0.9%, which is a staggeringly strong showing and well above forecasts of a 0.3% contraction. To put it into perspective, this figure represents the strongest monthly performance since last April’s Royal Wedding bonanza. On the back of December’s strong retail sales growth, this represents an excellent start to the year.

In terms of what products pushed this growth figure so high – January clothes sales were not responsible, rather it was fuel, sporting and household goods leading the way. The UK must be getting more health-conscious; food sales shrank and sportswear sales grew impressively. The hefty discounts seen on UK high streets are obviously being received well at consumer level but it doesn’t reflect well on UK shop-owners, who are quite clearly desperate to stay afloat. A recent report revealed that on average fourteen UK shops closed a day in 2011.

Discounts have obviously had an enormous role to play in the retail sector’s bumper month in January. However, lower prices will have played their part. Last year was characterised by soaring inflation caused by higher VAT, elevated commodity prices and a weak GBP, which saw UK CPI reach highs of 5.2% last September. However, inflation declined sharply to 3.6% in January, which gives an indication as to why UK shoppers stepped up their spending. UK CPI is expected to continue declining aggressively in the coming months, which will be a huge relief to British consumers.

Thursday’s nationwide consumer confidence survey provided an indication as to an improved high street sentiment. The survey jumped to a five month high but still, confidence levels remain at historically very low levels and no one saw this retail sales growth coming.

Nonetheless, the need for caution with regard to the near-term hopes for UK consumers is overwhelming. Household incomes continue to be tightly squeezed and wage growth has been minimal.UK unemployment is soaring and expected to rise further this year.

The UK economy shrank by 0.2% in the last quarter of 2011 and it must rebound into positive territory this quarter if it is to avoid falling into a second technical recession in the space of three years. Fortunately, the Bank of England’s additional quantitative easing appears to be working – January’s growth figures, led by the UK services and retail sectors, have been remarkably positive and a double-dip recession may just be avoided.

With tensions surrounding the eurozone’s growth and debt profile ever-increasing, the near-term outlook for the UK economy has rarely been more uncertain. If the crisis escalates further, the UK economy will be more or less powerless to avoid negative growth.

January’s rate of growth can surely not be sustained throughout Q1 but the unexpected upturn we have seen in recent weeks is welcome nonetheless. From a currency perspective, it has benefited the pound as well, GBP/USD is at a three-month high and GBP/EUR has recently tested a seventeen month high.

Richard Driver
 
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Moody's downgrades UK outlook but AAA remains intact

Ratings agency Moody's last night slapped the UK with a downgrade to its ratings outlook, doing the same to France and Austria. Moody's also cut the ratings of Italy, Spain, Slovenia, Malta, Portugal and Slovakia. Not the sort of news Europe was hoping to wake up to.

So what's the significance?

We don’t see Moody’s decision to downgrade the UK ratings outlook as overly worrisome. It is just a warning but all the warning signs were already there; it stands to reason that negative growth and climbing public debt will result in a loss of the UK’s AAA rating. Still, after the recent strong PMI figures and last month’s improved public borrowing figures, Moody’s warning will come as a bit of kick in the teeth. Nonetheless, UK debt has climbed over £1trn and the UK ecoonmy looks hard-pushed to grow its way out of trouble any time soon. The Q1 outlook for UK growth is fairly grim but we should see it pick up later on in the year as things stand.

The deciding factor will be developments in the eurozone - regardless of the UK government’s attempts to boost growth whilst cutting debt, if the eurozone crisis escalates then they will prove largely irrelevant. The liquidity operations have reduced the risks of a major collapse in the eurozone but the situation remains incredibly uncertain.

Greece has passed the necessary austerity package and has thus gone a step closer to receiving a second bailout that will avert a messy Greek default in March. However, further budget cuts need to be agreed, a debt-swap still needs to be agreed, and the Troika need to be convinced that Greece can implement its austeirty promises. All this and we face the uncertainty of a Greek general election in April, which inevitably opens the door to policy u-turns. On balance, the UK may just be able to hang on to its AAA rating, provided the European financial system buys enough time to shore itself up.

Sterling has taken the warning from Moody’s in its stride – GBP/USD came off a little last night but this was mainly EUR/USD driven and it has found support at $1.57 regardless.

€1.19 (84p) should hold firm for GBP/EUR, whilst GBP/USD should be able to climb a little higher in the short-term before we see a reversal.

This morning’s UK inflation figure has also failed to leave much of a mark, the market is well aware that prices are set to ease sharply in the coming months.

Richard Driver
Analyst – Caxton FX

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Weekly Round-Up: UK economy picks up, Greece stalls

Greek issue drags on…and on

The euro is holding up remarkably well given the weight of concern that is surrounding Greece and indeed Portugal. Last Monday’s (30th Jan) EU Summit saw Germany’s deficit control proposals finalized and the official scheduling of the €500bn permanent bailout fund’s (the EFSF) introduction for July this year. Positive steps but hardly game-changers.

The issue that continues to obsess the financial markets is Greece. Talks over private sector involvement in a Greek debt swap, which will involve significant write downs on investor holdings of Greek debt, have been the primary focus of the markets for some time now. Agreement is required for Greece to receive the €130bn it needs to avoid default in March. Time and again we have been assured a deal was imminent, but deadlines have been repeatedly been missed and negotiations are ongoing. On balance, there is probably a feeling that a deal will be reached in the end, which will avoid a Greek default for now. However, we are not anticipating a major euro relief rally on the back of any positive announcement.

This is explained by the issues that remain even if a Greek default is averted. Portugal is clearly next in the firing line; Portuguese bond yields reaching fresh record highs is evidence of this. Rating agency Fitch added to the pressure in the bond markets by downgrading several eurozone states last week, including heavyweights Spain and Italy. The euro has actually made a strong start to the year, largely as a result of short-covering, but we maintain a bearish view on the single unit.

UK growth figures raise hope of U-shaped recovery

Last week’s UK PMI figures were broadly very encouraging; the services sector grew at its fastest pace in ten months, whilst the manufacturing sector bounced back into positive growth. The UK construction sector posted another poor figure, but the data as a whole represents a source of hope that Britain can avoid a double-dip recession. This week’s manufacturing and industrial production figures are also expected to return to growth.

This will all be insufficient to dissuade the Bank of England from introducing further monetary easing to the UK economy at Thursday’s meeting (in the form of further QE). However, it should be enough to convince Mervyn King & Co to add £50bn rather than £75bn of QE, which should reduce the downside risks to sterling. The ECB also meet on Thursday and it could well cut its 1.00% interest rate by a further 0.25%, though they may choose to wait a further month.

US recovery continues to impress

Economic figures out of the US economy are on a clear uptrend at present. This was evidenced most importantly by the key monthly labour market update, which revealed 243 thousand jobs were added to payrolls (the most in nine months). Risk appetite away from the US dollar increased as a result of the announcement, but has since been hemmed in by growing frustrations surrounding Greece.

Sterling is trading at 1.2050 against the euro, in the middle of a range that has persisted throughout the start of this year and should continue to do so over the coming sessions. Trading up at $1.58, sterling is performing excellently against the US dollar and may keep on climbing for now, but is due a pullback soon.

End of week forecast
GBP / EUR 1.2025
GBP / USD 1.5850
EUR / USD 1.3180
GBP / AUD 1.46

Richard Driver
Analyst – Caxton FX
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Weekly Round-Up: Markets are punishing the euro

EU Summit fails to satisfy the market

Movements in the exchange rates yesterday indicated a clear dissatisfaction with the decisions (or lack thereof) made at last Friday’s ‘crunch’ EU Summit. Various commitments were made, notably in the form of a new fiscal compact that will usher in tighter budget deficit rules. This will guard against future sovereign debt crises cropping up in the future, but it doesn’t do a great deal to solve, or ease concerns surrounding the current and worsening eurozone debt crisis. The European Stability Mechanism (the permanent bailout fund) will be activated a year early in mid-2012 – another longer-term measure. A further €200bn of aid will also be made available – positive but hardly the sort of ‘bazooka’ style measure that has been mooted of late.

The European Central Bank has refused to step up its bond-buying and Italian bond yields have risen as a result. This reveals what the market thinks of the decisions made at last week’s Summit. Moody’s has joined fellow ratings agency Standard & Poor’s in warning of possible eurozone debt downgrades. Moody’s cited “an absence of decisive policy measures.” Decisive is the operative word here and the adjective that continues to elude EU leaders. With all three of the major rating agencies posturing, further eurozone downgrades are looking likely - the euro appears more vulnerable than ever.

The euro guarded against losses in the immediate wake of the EU Summit, but it has made a terrible start to this week. The market has had to come to terms with, and is pricing in, the fact that this eurozone crisis is going to roll on for months to come. This should not come as too much of a surprise, but expectations of ground-breaking progress really had reached new levels in the past fortnight. Accordingly, GBP/EUR has posted new nine-and-half month highs up towards €1.1850, and the euro has crashed towards fresh lows towards 1.3150 against the US dollar. The euro has fallen and fallen hard, and our pessimistic view of EU political stalling is finally being reflected in the exchange rates. In addition to the headline fiscal issues plaguing the euro, data this week is likely to highlight the economic issues the eurozone is facing. Eurozone manufacturing and services data is likely to stoke prevailing fears of another eurozone recession on Thursday.

Sentiment towards the US economy improving

Away from the furore surrounding the EU Summit, US consumer sentiment data hit a six-month high on Friday, providing further indication that the slowdown we have seen across the Atlantic for much of this autumn may well just be temporary. Caution will persist however, particularly with US retail sales figures disappointing today.

The picture is gloomier here in the UK; employment (Wednesday) and retail sales data (Thursday) provides plenty of scope for some sterling negativity as the week progresses.

Sterling is trading impressively above €1.18, and the euro looks hard-pushed to rebound in the current low-confidence environment. Key options levels at $1.3250 on the EUR/USD pair have now given way and safer currencies such as sterling and the US dollar have made an excellent start to the week. We can expect there to be further volatility this week and it certainly won’t be one-way, but we do expect the current risk-off climate to favour safer currencies and punish the euro. Currently trading at $1.56, sterling has held up pretty well against the US dollar, but a heavy EUR/USD pair should limit any upward sterling moves.

End of week forecast:
GBP / EUR 1.1850
GBP / USD 1.5550
EUR / USD 1.3125
GBP / AUD 1.5450

Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

ECB rate cut could be positive for the euro

There have been plenty of positive developments for the eurozone of late. The IMF looks increasingly likely to be a third line of defence and it has been agreed that the European Financial Stability Fund will be able to guarantee up to 30% of troubled eurozone state’s bonds.

Most importantly, six major central banks last week announced coordinated liquidity measures to take the pressure out of the global, and particularly the European banking system. The unified emergency response has given appetite for riskier assets such as the euro a real shot in the arm.

We have also seen some progress in Italy, with new PM Mario Monti announcing a fresh 30bn austerity package, which should serve to appease the markets for the time being.

All eyes now turn to the Thursday’s monthly interest rate decision from the European Central Bank. A higher interest rate is typically positive for a currency and a rate cut a distinct negative. However, circumstances in the eurozone are anything but normal and a second consecutive monthly rate cut to the ECB’s base rate (currently 1.25%) could well be taken as sign that EU officials understand the gravity of the region’s problems and are acting proactively and assertively. Other liquidity measures are also likely to be announced by ECB President Draghi.

Friday brings a key EU Summit which has been hyped as ‘make or break.’ This is a bit overdone but there are plenty of signs that we will see some decisions made on fiscal union amongst eurozone states. Headlines today reveal that Merkel and Sarkozy have reached an accord on eurozone budgets and potential sanctions. The markets have been disappointed before and whilst investors are likely to hope for the best while the positive headlines flow, but many will be preparing for the worst.

Conditions in the US improve but not so for the UK

US economic figures have broadly taken a turn for the better in the past fortnight, suggesting the US economy can have a stronger 2012 than has recently been indicated. This has added to the improved sentiment in the market in recent sessions.

UK data has been less impressive; November’s UK construction and manufacturing figures revealed a further slowdown and have done little for the prospects of final quarter growth. Services sector growth enjoyed a minor uptick but levels are well off what we were seeing earlier in the year.

George Osborne was very negative indeed about the prospects for the UK economy in his Autumn Statement. The Bank of England will be sitting on the sidelines until February as far as more quantitative easing is concerned, so we will just have to hope that activity picks up in the next few months.

Sterling is trading at €1.1650, off its recent highs above €1.17 in light of an upturn in global risk appetite. Against the US dollar, sterling is trading more robustly up at $1.57, having bounced of lows of $1.54 in late November. We don’t see any major moves in the GBP/EUR pair this week but we may see EUR/USD continue to head higher as equities recover. This should keep GBP/USD well-supported, regardless of the growing concerns surrounding the UK economy.

End of week forecast
GBP / EUR 1.16
GBP / USD 1.5750
EUR / USD 1.36
GBP / AUD 1.50

Richard Driver
Analyst – Caxton FX
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Euro Panic: Greek default back on the table

EU Summit made progress but Greece drops a bombshell

The European debt crisis has dominated market sentiment over the past few weeks but last week saw some progress made. The EFSF (bailout fund) is to be leveraged and expanded by almost five times (to €1trn).There is to be a €110bn recapitalisation of Europe’s banks, and there is to be a 50% haircut on Greek bond holdings. The market received the plan positively but confidence has since waned and the euro’s gains have been reversed. There remain major question marks, such as how the fund will be leveraged, and how EU leaders intend to get eurozone growth back on track.

But most alarmingly, the Greek situation has hit the headlines once again, with Greek PM George Papandreou allowing a referendum on last week’s €130bn bailout package. This is a real revelation and the prospect of a messy Greek default is very much back on the table now. The euro has given away over five cents to the dollar this week already, mirroring sharp losses in global stock markets. In addition, Italian bond yields are consistently hitting fresh euro-era highs.

The market awaits clues as to central bank monetary policy

Also in focus this week are monetary policy decisions from the US Federal Reserve and the European Central Bank. The Fed looks unlikely to announce QE3 at its meeting this Wednesday. Particularly on the back of last week’s stronger than expected GDP figure, which showed the US economy grew at an annualised rate of 2.50% in Q3 2011. Forward looking US data is nonetheless pointing towards a slowdown, and the market remains hopeful for another round of QE from the Fed. First quarter 2012 remains a decent bet, which is likely to weigh on the US dollar in the long-term.

The European Central Bank will meet on Thursday, which will be Mario Draghi’s first as President of the central bank. There is a chance of an interest rate cut but our bet is that with inflation at 3.0%, we may have to wait at least a month for the ECB to loosen monetary policy. The real driver of the euro is likely to be how the Greek crisis progresses from its latest negative turn.

Q3 UK GDP impresses but the market wasn’t fooled

Estimated UK growth data for the third quarter was 0.5%, above expectations and well above Q2’s 0.1% figure. Sterling has failed to rally however, as the simultaneous release of October’s manufacturing PMI growth pointed to a very gloomy Q4 performance. The figure was the worst in over two years and triggered major concerns about another UK recession and further QE from the MPC.

Sterling is trading just above €1.1650 today, which is close to a three-month high. This week looks set to be a tough one for the single currency, and although there are downside risks posed by this week’s UK services and construction growth figures, GBP/EUR may continue to trade strongly this week. In line with renewed Greek concerns and plummeting global stocks, we are likely to see the safe-haven dollar outperform both the euro and the pound in coming sessions. Friday’s US Non-Farm payroll figure could well reveal further fault lines in the US recovery and intensify risk averse trades. Major headlines out of the eurozone, as ever, will trump fundamental data, but these are proving more unpredictable than ever.

As ever, views are very welcome!

Richard Driver

Analyst – Caxton FX

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EU deal sends the euro soaring

The euro is going from strength to strength today in the aftermath of yesterday’s EU Summit package. Have EU leaders solved the problem? No, not by a long way but they exceeded expectations and the market has welcomed it with open arms. US and European equities are booming (the FTSE is over 2.5% up), as are riskier currencies such as the aussie dollar and the euro.

Decisions have been made on all three of the key issues of contention -bank recapitalisation, Greece’s debt burden, and the eurozone bailout fund. European banks will benefit from around €100bn worth of recapitalisation, in order to deal with losses stemming from Greece. On the Greek debt issue, a 50% haircut has been agreed. With regard to the bailout fund (the EFSF); it is to be expanded by almost five times next month (to around €1trn).

There were rumours of a lack of progress and delayed decisions throughout yesterday, so these plans have triggered a wave of positive trading throughout the financial markets. Concerns surrounding the various holes in the plans (How will the EFSF be leveraged? Are the haircuts really voluntary? What about eurozone growth?) have been put on the backburner for now but will undoubtedly resurface. There is plenty of negotiation ahead, which means plenty more disagreement and plenty more alarm bells. Italy remains very vulnerable in the debt markets and it still remains to be seen whether the decision to write down Greece’s debt will succeed in putting the country on a sustainable footing.

If the euro is to kick on further from here, the trigger is likely to come from outside. One method of expanding the EFSF is through external investment from countries like China or Brazil. It is no secret that Asian sovereigns are eager to diversify away from the dollar and into the euro, so such investment would make sense. It is not beyond EU leaders to fail to implement this plan, or for the deal to collapse altogether. The risk is there, but you have to say the recent deal certainly brightens the prospects of the euro in the longer-term.

Richard Driver
Analyst – Caxton FX


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Monthly Swedish Krona Report: Risk appetite returns

September was another month of low market confidence and risk averse trading. The worsening state of the European banking system, as a result of a continued lack of progress on the eurozone debt crisis, saw investors flooding out of higher-yielding currencies into safe-haven currencies. Concerns over global growth have also been very prominent in recent weeks, with increased speculation of a plunge back into recession for the eurozone, the US and the UK.

However, there have in recent sessions been some signs of progress in the eurozone however, which has been positive for risk appetite. Merkel and Sarkozy have ‘committed’ to providing a comprehensive plan to deal with the Greek issue, the recapitalisation of Europe’s banks, and poor growth in the eurozone. At present this just represents rhetoric and yet another promise, but it has been received enthusiastically by the market. The two EU leaders have set themselves a deadline of November 3rd. In addition, the eurozone bailout reform looks almost certain to be fully ratified by Slovakia, the last member state to accept the fund’s expanded powers.

The performance of the Swedish Krona is being dictated more than ever by international developments than by domestic issues. Accordingly, improved market confidence has helped the krona to recoup some decent ground in the past week or so, after spending September very much on the back foot.

EUR/SEK
The euro benefited from the ECB’s decision not to cut its 1.50% base rate in early October. Speculation was rife that the ECB would lend the ailing periphery a hand, particularly in light of an economic slowdown in the eurozone’s core nations, so the interest rate hold represented a relief. The Riksbank also decided to hold interest rates at 2.0%, which was in line with expectations. Growth has slowed down significantly in Sweden and inflationary pressures are subsiding; the Riksbank has recently confirmed that “the financial crisis has probably lowered the growth rate of potential GDP.”

In line with the Swedish krona’s riskier profile, this pair posted fresh 2011 highs up above 9.35 in late September as fears grew of a messy Greek default and a Lehman’s style fallout. These krona losses have since been corrected and this pair is actually trading flat on the month. Optimism surrounding the chances of some genuine and concrete action in Europe is prevailing at present and it certainly brightens the krona’s prospects.

In addition and importantly, the Troika (the ECB, IMF and EU) has indicated that Greece will receive its next emergency loan in November. Granting further aid to what many believe is a ‘lost cause’ may sound like madness, but the market is inherently concerned with the short-term. This next Greek aid tranche allows EU officials the time to avoid a near-term Greek default and to work on a credible long-term solution.

The market has certainly enjoyed some positive stories of late and risk appetite has clearly returned to favour the krona, but there will undoubtedly be some stumbling blocks to come with regard to eurozone progress (as demonstrated by Slovakia’s recent ‘no’ vote on the bailout fund reforms). Positive sentiment has taken this pair down to 9.16 and the coming weeks look likely to help the krona maintain these levels, though 9.10 will probably provide some fairly stiff support on the downside.

USD/SEK
The dollar performed excellently in September, benefitting from plummeting global stocks and the associated heightened demand for safe-haven assets. The dollar found even more favour because of ongoing issues surrounding the two other haven currencies; the swiss franc is suffering from currency intervention by the Swiss National Bank and threat of similar action surrounds the yen.

However, market confidence is on the up at present and the dollar strength that characterised September has been largely unwound. Still, the greenback will be the key beneficiary of any alarm bells that do emerge out of the eurozone.

The US dollar remains vulnerable to domestic events. At its meeting last month, the US Federal Reserve decided against introducing a third programme of quantitative easing (QE3). Instead, it introduced Operation Twist, in which it sells short-term bonds and buys long-term bonds. The market was noticeably unimpressed but hopes for QE3 remain very much on the table. Should the Fed decide to add further stimulus to the US economy, global stocks would spike and the dollar would suffer a further downward correction on top of what we have seen in recent sessions. We are betting that the QE3 measure will be saved by the Fed for the worst case scenario (another US recession). Consequently, we don’t see this downside risk event occurring in coming weeks, but it is still likely to weigh on investors’ minds.

The USD/SEK rate hit a 9-month high of almost 7.00 in early October, but this climb has been erased and the rate is back down below 6.70. Continued improvements in investor confidence levels may see the rate head down towards 6.50, but dollar losses beyond this look to be a bridge too far.

GBP/SEK
Sterling has suffered as a result of the Bank of England deciding to introduce additional quantitative easing. The MPC voted to increase asset-purchases by £75bn and predictably, sterling has come under severe pressure. Economic data from the UK has been poor of late; indeed the revised second quarterly figure for UK GDP was halved to a paltry 0.1%. It is an equally gloomy outlook for the third and fourth quarter GDP figures, combined with downside risks to inflation and an increasingly dovish-sounding MPC, which makes yet more quantitative easing a real possibility.

Again, the performance of this pair in the coming weeks is very much dependent on how risk appetite pans out. The current rate stands at 10.50, but the recent good news stories of action and commitment in the eurozone should see the krona hang on to its impressive recent gains. That said, sterling’s slide looks a little overdone and further downside too far below 10.50 should be capped.

NOK/SEK
This pair has remained range-bound between 1.16 and 1.19 levels for the past four months or so now, excluding a brief spike to 1.20 in early September as a result of panic related to the Swiss National Bank’s intervention. On a fundamental economic basis, the Norwegian krone shades its Swedish counterpart but there really is very little to choose between these two currencies at present.

The Norges Bank Iooks highly likely to leave interest rates on hold at 2.25% until the middle of next year and the Riksbank will be unwilling to resume hiking until the financial uncertainty in the eurozone has subsided. One major factor limiting the NOK’s upside is that he Norges Bank has made it quite clear that it will not allow the currency to strengthen significantly and is willing to cut interest rates to buffer against this.

This pair is currently trading around the 1.18 mark and it is highly likely that we will see it continue to fluctuate within the 1.16-1.19 range for the next few months.

Richard Driver
Analyst – Caxton FX
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Dollar strength: Is it here to stay?

The pound has tumbled to a one year low against the dollar today. The pounds slide has been pretty staggering; we have seen GBP/USD fall from $1.65 to the current rate of $1.5350. Why?

The collapse is a result of several factors. First, sterling is fundamentally an immensely unappealing currency. The MPC last month voted in its entirety for a hold to the record low Bank of England interest rate of 0.5%, meaning the two remaining hawks had abandoned their quest for an interest rate hike. With inflation expected to fall fairly rapidly next year, and with UK growth clearly on a downtrend, the market has given any hopes of a higher UK interest rate. The recent MPC minutes reveal that they are very close indeed to pulling the trigger on introducing further quantitative easing.

Second, the euro/dollar pairing has collapsed. The GBP/USD rate to a large extent tracks the EUR/USD pairing, which has suffered a ten cent collapse in the past month. Concerns surrounding the eurozone debt crisis have finally taken their toll on the single currency with Greece seemingly certain to default at some point and with no long-term solution in sight. The UK’s proximity and exposure to a eurozone debt and a potential Lehman’s-style collapse in the European banking system, has also weighed on sterling and triggered huge euro-dollar flows.

Third, concerns over US and wider global growth have contributed to a hugely ‘risk off’ trading environment. Riskier currencies such as the Canadian, kiwi and Australian dollars are selling off as investors flee to the safety of the dollar. The huge losses in global equities that we are seeing will always benefit safe-havens such as the dollar. The fact that the US economy is in such a fragile state makes little difference, in fact the extent to which the world’s largest economy is struggling only intensifies the safe-haven flows which are benefiting the dollar.

Finally, the dollar is enjoying a greater share of the safe-haven pie. This is because the former safe-haven of choice, the swiss franc, has lost its appeal. The Swiss National Bank has intervened in the currency markets to curb the excessive strength of the swissie, so the market has been scared off. Though it has been unsuccessful in its interventions of late, the Bank of Japan nevertheless looks likely to take similar action to weaken the yen. USD/JPY is at record lows near 76.00, so the Bank of Japan’s patience is certainly being tested.

Do we see sterling making further losses to the dollar? Yes we do. There seems to be little on the horizon to fuel much of a sterling rebound. Contrastingly, fears over global growth look likely to persist. Likewise, the other major concern- the eurozone debt situation, looks unlikely see any significant progress in the near future. The outlook is very positive for the US dollar then, albeit the opposite is true for the US economy.

Richard Driver
Analyst – Caxton FX

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MPC minutes reveal increased chance of UK QE.

This morning’s MPC minutes have weighed heavily on the pound today. The Bank of England’s rate-setting committee revealed that growth in the second half of this year is likely to be “materially weaker than forecast in August.” The minutes also indicated that a move towards additional UK quantitative easing “was finely balanced for most MPC members” and that “it was increasingly likely that [it] would be warranted at some point.”


Significantly, leading MPC dove Adam Posen was not joined by any of his colleagues in his call for an additional £50bn worth of asset purchases. However, the comments above really do look to be the precursor to further easing and the market has taken its cue to hurt the pound. Today’s news doesn’t come as too much of a surprise after the Bank of England’s third quarterly bulletin, which celebrated the effects of the last round of quantitative easing.

The market is now looking ahead to next month’s Bank of England meeting, where they may well finally pull the trigger on QE. The truth is that UK data is on a steady downtrend and most signs are really pointing towards a double-dip recession.

Sterling has come off highs up above €1.17, to trade at levels comfortably below €1.14 this afternoon. Do we see this lasting? Well, we find it difficult to envisage the euro maintaining this level of support in the medium term. There remains a sense that the next scare or damaging bad news headline from the eurozone is never far from view. Admittedly, the euro has traded robustly in the face of Italy’s debt downgrade yesterday but the Greek issue is still unresolved. In addition, sterling has suffered of late with the UK economy in the spotlight, but attention is likely to shift away until early October’s PMI data. This may give sterling a little breathing space over the coming week and a half or so.

Richard Driver
Analyst – Caxton FX


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Caxton FX Weekly Round-up

Eurozone concerns peak and the euro plummets
Concerns over the eurozone debt crisis have peaked in recent sessions, which has seen the key euro/dollar pairing decline by nine cents in the space of a fortnight. Fuelling this sell-off, which has also seen the euro hit a ten-year low against the yen, are intense fears of a Greek default. Greece is not meeting its deficit targets and unless sufficient austerity measures are implemented, then it may not receive its next tranche of aid.

German patience with Greece, which has been crucial in maintaining confidence in the euro, is clearly wearing very thin. Comments from politicians in the leading eurozone nation have alluded to a possible default and Greek exit. The market is now estimating that the probability of a Greek default within the next five years is 98%. A default and the effects it would almost certainly have throughout major eurozone nations such as Italy and Spain cannot yet be fully priced in. Accordingly, the euro has plenty of downside potential.

Importantly, we have seen Asian sovereigns withhold their previously reliable support for the single currency. Rumours of Chinese support for Italian debt stabilised the euro’s fall on Monday, but this seems highly unlikely to provide any sustained euro relief rally. Italian bond yields also soared at a debt auction today regardless. In addition, France’s main banks are facing further downgrades due to their exposure to Greek debt.

The ECB looks increasingly likely to cut its interest rate, which along with solid Asian support, has driven the single currency to such strong levels. The absence of these two factors and the worsening of the eurozone debt crisis have caused us to revise our relatively bullish outlook on the euro. The imminent threat of a Greek default and a collapse in the European banking system should ensure further euro weakening in both the short and longer term. The effect of eurozone officials’ habit of much talk and little action seems likely to ensure that any solution to the eurozone crisis will be very slow in coming and market scepticism is growing all the time.

Bank of England holds fire on QE
Last week saw the Bank of England decide against introducing further quantitative easing to the UK economy. Recent PMI data from the UK was very poor so the speculation for monetary easing certainly built ahead of last Thursday’s announcement. Next Wednesday’s MPC minutes will reveal just how close the BoE policymakers were to pulling the trigger. As ever, if figures continue to weaken, the measure will continue to threaten to weaken the pound.

Sterling is trading fairly strongly in the current risk-off environment, except against the dollar which has gained in safe-haven inflows since the Swiss National Bank’s intervention in the swiss franc’s strength.

After trading at €1.17 early on Monday morning, sterling is trading a cent and a half lower but the risks of further euro-weakening are all too clear. Against the dollar, sterling is trading down at $1.58 and is looking significantly more vulnerable. The key factor governing this outlook is an even weaker looking euro/dollar pairing, which looks hard pushed to make a sustained move back above $1.40 in the current environment.

End of week forecast
GBP / EUR 1.16
GBP / USD 1.57
EUR / USD 1.3550
GBP / AUD 1.5350

Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Caxton FX Weekly Round-up

UK growth data disappoints

The monthly instalment of growth data from the UK economy was weaker than expected. The manufacturing sector contracted again, and we saw the sharpest slide in the UK services sector in a decade. Sterling has not suffered too much as a result (except against the dollar), with the market focused on wider global concerns. The Bank of England meets again this week and there is likely to be increased discussion of monetary easing in light of recent economic data. Our bet is that given the UK services sector remains in expansionist territory, they will hold fire for now.

Poor US non-farms data adds to QE3 speculation

There was some promising data from the US last week; PMI data from Chicago was impressive, as was a factory orders figure. However, some awful consumer confidence and non-farm payrolls data stole the headlines. The former gave its worst showing in over two years, and the latter gave its worse showing in almost a year. The safer dollar is therefore outperforming at present, with global stocks in decline amid the familiar concerns over global (and particularly US) growth and the eurozone crisis.

Nonetheless, we are sticking to our longer-term forecast of a weaker US dollar. The Fed will be having an extended discussion as to monetary policy responses to the US economic slowdown at its meeting this month. If data continues to decline, we may well see Ben Bernanke’s hand forced on QE3. The major US data releases this week include non-manufacturing PMI data on Tuesday afternoon and trade balance data on Thursday. In truth though, the dollar’s performance this week will probably depend on risk appetite and activity in the global equity markets. The dollar is approaching the upper limits of its trading ranges against both the euro and the pound at present. We doubt that there is sufficient momentum for the dollar to push through these barriers, though there remains significant risk.

Eurozone concerns weigh on the single currency

Merkel suffered another German election defeat, this time in her home state, which has added to already heightened market uncertainty. The growing signs of domestic frustration at Germany’s leading role in eurozone bailouts are a real concern. In addition, the market is nervous ahead of Wednesday’s constitutional ruling from a German court on the country’s contribution to the bailouts.

Greece is also back in the headlines, with various nations demanding collateral for their contributions to the troubled nation’s second bailout, and with Greek officials in disagreement with the IMF/EU/ECB over further budget cuts. With all these eurozone issues weighing and more besides, EUR is definitely on the back foot. Nonetheless, Asian sovereigns have been very reliable in buying the euro on dips this year, and with EUR/USD at $1.41, the euro looks unlikely to fall too much further.

Sterling is trading at 1.14 against the euro; it has a little more upside but should meet some fairly stiff resistance around €1.15. These look to be poor levels for GBP/USD, which is very close to multi-week lows. We are confident EUR/USD and GBP/USD will bounce this month, but this may have to wait for this week.

End of week forecast
GBP / EUR 1.14
GBP / USD 1.62
EUR / USD 1.42
GBP / AUD 1.5350

Richard Driver
Senior Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Caxton FX Monthly Outlook

August saw a collapse in global investor confidence which triggered huge losses in the stock market. Rating agency Stand & Poor’s downgrade of US debt proved the catalyst, but a variety of issues contributed to the slide in sentiment; global growth is stalling, the US economy is nearing another recession, and a long-term solution to the eurozone debt problem continues to evade us.

The US dollar and other safe-haven assets strengthened considerably amid the huge uncertainty that prevailed in early August but prospects for the dollar look negative. The Fed has announced that the US interest rate will remain at record lows until mid-2013, and debate within the central bank surrounding ‘QE3’ (further US quantitative easing) is ongoing. US economic data has broadly been very disappointing in recent weeks; hopes of a H2 pick-up in growth are diminishing and bets on another US recession are increasing.

Sterling enjoyed a strong few weeks, offering investors some safe-haven appeal of its own. With US and eurozone issues dominating the headlines, and with the Swiss National Bank and Bank of Japan taking measures to devalue their currencies, the market looked to sterling as a safer alternative. With confidence returning and risk appetite recovering, this theme has been reversed in the past week and the pound’s prospects are bearish; a poor growth outlook and a dovish central bank are weighing heavily.

Sterling/Euro

Eurozone concerns are at a reasonably low ebb at present; despite bond yields still at elevated levels, the ECB’s programme of buying Spanish, Italian, Portuguese and Irish bonds is a show of commitment that has gone some way to calming fears. Nonetheless, frustrations remain; the European Financial Stability Fund has not been expanded and is thus insufficient in size to deal with a Spanish or Italian bailout.

The proposal of a common eurobond has been rejected by Merkel and Sarkozy. Vague commitments to common governance and a Tobin tax were the main results of the two leaders’ last meeting, neither of which inspired much confidence. However, judging by the strength of the euro, the market seems willing to wait for officials to work out a longer-term answer to the eurozone’s structural debt problem.

The outlook for the ECB interest rate outlook is coming under increased scrutiny, in light of a slowdown in quarterly growth figures from Germany (0.1%), France (0.0%) and eurozone as a whole (0.2%).This slowdown is in line with a global trend however, as shown by a second quarter UK growth figure of 0.2%. It should be noted that Trichet was slightly more dovish at last month’s ECB press conference but nevertheless, the ECB have shown they are dedicated to controlling eurozone inflation and rate cut seems unlikely at this stage. The eurozone’s higher interest rate (1.50%) will continue to attract investment moving forward.

Last month’s MPC minutes made the UK interest rate outlook even more dovish, with the two remaining MPC hawks (Weale and Dale) abandoning their quest for a BoE interest rate hike. In addition, the recent Quarterly Inflation Report indicated a calmer outlook for inflation next year. With UK growth so weak, there is little pushing the BoE towards monetary tightening now.

Indeed, there is substantially more chance of further UK quantitative easing than of a rate hike. Last month’s manufacturing and construction PMI data was poor, as were retail sales and unemployment figures. The only saving grace was some strong growth in the UK services sector, which was enough to stave off fears of further UK quantitative easing for the time being. A poor showing in August’s PMI figures in coming sessions could well see this pair drop considerably, all eyes will be on the all-important services figure.

Sterling looks distinctly vulnerable to further falls against the euro. Global stocks are recovering in line with a return of risk appetite, which favours the single currency. The key driver of the euro also remains firmly in place - Asian sovereign diversification away from the dollar into the euro. With multiple bailouts in recent months and questions hanging over Spanish and Italian debt, and now concerns over German and French economic growth, the resolve of far eastern buyers has been tested but the euro seems destined to remain strong.

We have seen highs up at €1.1550 but this pair is trading back down at €1.1350 at present. In accordance with a weakened outlook for the US dollar, a dip down towards the key EUR/GBP target of 90p, which is equal to €1.1111, seems a decent bet.

GBP/USD

This pair remains true to its longer-term range of $1.59-1.67, with both currencies hemmed in by domestic economic underperformance. There have been some truly alarming US economic figures in recent weeks that have contributed significantly to the decline global stocks. US second quarterly growth undershot expectations (showing 1.0% expansion on an annualized basis) and Philly Fed manufacturing and consumer confidence data slid to levels not seen since the recession.

The Fed has responded by pledging to keep the US interest rate at its current record-low for two years to come, until mid-2013. Speculation of a third round of US quantitative easing has been rife over recent weeks and hopes were high for indications at Bernanke’s Fed press conference and his recent speech at Jackson Hole. The Fed Chairman has held fire on further monetary easing for now but the measure remains very much on the table. If data continues along its current downtrend, then the Fed will have to pull the trigger; many will have their sights set on the Fed’s September meeting. The meeting has been extended to two days, a reflection of the depth of debate surrounding the measures which the Fed is considering in order to stave off another US recession.

The longer-term impact of Standard & Poor’s downgrade of US debt (due to inadequate pledges of spending cuts) should not be underestimated. Looking ahead to next year, if the US government fails to address its fiscal position then further downgrades are likely; Standard & Poor’s has stated as much. The short-term fallout saw sterling fail to sustain a move higher against the dollar in the middle of August, having been rejected at $1.66.

The strength of the EUR/USD rate should keep sterling fairly well-supported against the dollar in coming weeks and months but we do not see any break of this pair’s longer-term range in the current climate. However, if US data does continue to worsen and the Fed does introduce QE3, a break towards $1.70 seems a very good bet indeed. In all likelihood, we may have to look beyond September for the Fed to pull the trigger, and this pair will continue to fluctuate in range in the short-term. An increasingly bearish outlook for the dollar, rather than sterling strength should mean that if there is any direction bias for this pair, it is to the upside from the current $1.62 trading level.

Caxton FX one month forecast:

GBP / EUR 1.12

GBP / USD 1.6350

EUR / USD 1.46

Richard Driver
Senior Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.

Bernanke fails to indicate QE3

Bernanke's speech at Jackson Hole, where at the same point last year he introduced QE2, has disappointed those hoping for a further programme of monetary easing, which would boost confidence, help to safeguard the US economic recovery, and improve the US stock market.

In truth, Bernanke's failure to pull the trigger on QE3 should not come as a surprise. The US economy is certainly in dire straits; its second quarter US GDP figure (annualised) was announced this afternoon to be a disappointing 1.0%. However, we may have to see the US recession dip back into recession, or at least come closer to doing so, in order for Bernanke to introduce QE3.

One key issue is that of US inflation. When QE2 was signalled, US inflation was falling, but at present the figure is rising and further monetary easing would exacerbate this. Another issue is that of dissent within the US Federal Reserve; the central bank is more prone to decisions by consensus and it would have been unusual for Bernanke to go ahead with the collection of high-profile, dissenting, fellow US policymakers we have heard from in recent weeks.

Bernanke stated that he is focusing on ways to promote US growth and improvements in the US labour market. However, this is not the end of the issue. The Fed is quite clearly willing to implement more quantitative easing, it is just setting the bar a little higher than many in the equity markets would prefer. The Fed's meeting minutes demonstrate that they are discussing the measure seriously as an issue.

So what's happened in the currency markets? Well, the US dollar rallied initially but gains have been erased. The was no new information provided by Bernanke. Do we the dollar hanging on to this week’s gains in the longer-term? No, we remain bearish on the greenback. Not even safe-haven flows seem likely to provide long-lasting support. An outlook characterised by low growth (and possible recession), high unemployment, ultra-low interest rates (and QE3?) and possibly further debt downgrades should ensure dollar-weakness.

Richard Driver
Caxton FX Anlayst


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