Update on UK and Cable…

The storm on the Euro also impacted the value of the British pound after Draghi’s speech in Brussels last month. Cable is now approaching its strong psychological support level at 1.6700 where there could potentially be some ‘buyers on dip’.

On the UK side, the BoE MPC met on Thursday but as expected nothing new concerning its monetary policy was released. The BoE is still seen as the first major bank to start raising rates in early 2015 (probably Q2); therefore investors are still interested in playing the monetary policies divergence between the major central banks (short EUR/GBP is a popular medium term position to hold at the moment). In addition, the National Institute of Economic and Social Research (NIESR) estimated today that the UK economy have eventually surpassed the pre-recession peak it reached in January 2008 after more than 6 years. NIESR are forecasting a 0.9% growth in the March-May period (tight slowdown compared to the 1.1% estimated between February and April), which would mean that the level of UK GDP stands 0.2% above where it was in January 2008. With an economy that almost faced a triple-dip recession in 2013, Britain has taken much longer time to recover compare to other ‘strong’ economies such as Germany or the US (both returned to pre-cisis level in 2010).

If we have a quick look at the economic indicators, we saw last week that Manufacturing, Construction and Services PMIs all stood well above the 50 (expansion / contraction) level at 57.0, 60.0 and 58.6 respectively. Moreover, industrial and manufacturing output both came in higher-than-expected at 3.0% YoY (vs 2.8% expected) and 4.4% YoY (vs 4.0% consensus) in April.

The rebound we have since in the US yields since the lows reached in the end of May helped the greenback recover against the major currencies this week. The graph below shows you one of Cable’s main drivers, the 2-year UK-US spread (in red). As you can see it, the spread narrowed by 10 bps since the end of May and now sits at 0.291%, which pushed Cable (in Yellow) down by 120 pips to 1.6750.

Cable-Spread

(Source: Reuters)

Based on this analysis, we will try to buy Cable at around 1.6720/30 for a test back towards 1.6800 (at first) with a stop loss at 1.6680 (below its 100-day MA at 1.6688).

FOMC meeting: the impacts

As expected, the Fed reduced the asset purchase programme by another $10bn in April to $55bn, adding $25bn of agency MBS and $30bn of LT Treasuries to its holdings every month. The surprise though came from the upward revision to the Fed funds rate, which is expected to increase to 1% or more by the end of 2015 (up from 0.75%) and to 2.25% by the end of 2016 (up from 1.75%). US interest rates increased sharply after the statement, pushing the value of the US Dollar higher (US Dollar index was up 60 pts to 80.10).

In addition, US policymakers lowered the 2014 GDP growth range to 2.8% – 3.0% (from 2.8% – 3.2% in December) and are targeting a 6.1% – 6.3% jobless rate by the end of this year (see the details below). With the unemployment rate standing close to the 6.5-pecent threshold (6.7% in February), Janet Yellen announced during her first conference as a Fed chair that the central bank would shift to a more qualitative approach and will consider a ‘wide range’ of variables instead of relying mainly on the unemployment rate.

(Source: Federal Reserve website)

Now let’s review the impacts of the Fed funds rate forecast change. Firstly, as you can see it on the chart below, the 10-year US yield increase by 10 bps to 2.77%, sending Gold to end-of-February lows (trading at 1,328 after the statement).

(Source: Reuters)

The FOMC meeting also put the Euro under pressure, a currency that has remained resilient in the middle of this Risk-ON / Risk-OFF market driven by Russian-Ukrainian tensions and the weakening Chinese Yuan episode. EURUSD, which had been traded around the 1.3900 level (1.3850 – 1.3960 range) for the past couple of weeks, was pushed back towards 1.3800 (1.3810 after the statement), frustrating the bulls (who were expecting 1.4000) and easing ECB concerns about a ‘strong exchange rate’.

EURUSD-FOMC

(Source: Reuters)

Eventually, Cable broke its 1.6545 support and found support slightly above the 1.6500 level. As you can see it on the chart below, the plunge in the 2-year UK-US spread (purple line) from 31.5 bps to 22.5 bps pushed the pair (orange) to mid-Feb levels. The 2-year spread has been one of the major drivers of Cable since Carney adopted the forward guidance in August last year. As unemployment rate has decreased faster than expected and is now standing close to the 7-percent threshold (7.2% in the three months to January), traders have been speculating on a rate hike in the first quarter of 2015. However, some MPC members put the British pound under pressure stating that a ‘strong exchange rate’ could weigh on the BoE’s decision to start tightening. With policymakers’ recent comments and an annual inflation at its lowest level since 2009 (1.9% YoY in January), the market is now pricing in a BoE action in the second quarter of 2015.

GBPUSD - Sp

(Source: Reuters) 

UK Budget: In the early afternoon, the Chancellor of the Exchequer Osborne presented the new budget and as expected, it contained a few surprises in the aggregate numbers of the deficit path (real news was the incentives for savers, which we are not going to cover in this article). As the UK economy is expected to accelerate this year (2.7% according to the Office for Budget Responsibility – OBR), the deficit is expected to decrease gradually in the following years and switch to a small surplus of 0.2% in 2018/19 according to the OBR.

Quick weekly review ahead of the Non-Farm Payrolls…

After tensions eased in Ukraine and China in the beginning of the week, risk appetite was back with AUDJPY up 4% since its low reached on Monday at 90.00. It helped the stock market recovered, with S&P500 and Eurostoxx 50 up by 2.5% and 3%.

Australian fundamentals also surprised traders: Q4 2013 GDP printed above consensus at 0.8% QoQ (vs 0.7% expected), January Trade Balance came in at 1.43bn AUD smashing expectations of 270mio AUD (exports went up 3.7% while imports rose 0.82%) and retail sales surged to 1.2% MoM in January (vs. 0.5% estimates) from a revised 0.7%. The pair broke its 100-day MA at 0.9080 to trade at 0.9112 in the late afternoon before coming back below the 0.9100 level. On the Asian side, the Yen dropped to a five-week low against the greenback (up 1.8% to reach a high of 103.16) after GPIF (world’s largest holder of JGBs) advisory panel announced that the fund ‘doesn’t need a domestic bond focus’ given quickening inflation.

As expected, the Bank of England kept its Official Bank rate steady at its record low of 0.5% (five years now) in order to help the UK economy on to a full recovery (UK grew by 1.8% in 2013, fastest pace in 6 year). Policymakers also announced that the central will reinvest GBP 8.2bn on a bond that it bought in its QE operations that was set to mature on March 14. As you can see it on the chart below (30-min period), Cable eased after the announcement until it found support at around 1.6685, then the pair surged for the rest of the (London) trading session. The gains were capped slightly above its ST resistance at 1.6760 and GBPUSD is now back in its 1.6660 – 1.6760 range. Poor US data tomorrow could bring the pair back above the 1.6800 level; the strong resistance on the topside stands at 1.6825 (Feb 17th high).

(Source: Reuters)

The big mover today was the Euro of course as Draghi ‘disappointed’ the market. He left the refi rate unchanged at 0.25% and gave a quite optimistic conference in the afternoon, which we believe pushed the single currency above the 1.3800 level against the greenback (EURUSD rose 120 pips approx. during the press conference to 1.3850). According to the ECB, the unemployment is stabilizing and the downside inflation risks ‘remain limited’. Policymakers also raised their growth forecast for the Euro area by 0.1% to 1.2% for the year 2014 and are expecting a 1.8% inflation rate in 2016 (still concerned about the inflation rate for 2014, revised lower to 1.0%).

Having said that, we are now wondering if we could see a turning point tomorrow ahead of (or straight after) the US employment data. Yesterday, ADP reported that the US private employers added ‘only’ 139K jobs in February (vs. 160K expected) with January’s print revised lower to 125K (from 175K), and we saw that non-manufacturing PMI fell to a four-year low to 51.6 (from 54.0 in January and vs 53.0 cons.) with the employment index contracting for the first time in two years (from 56.4 to 47.5). we saw this chart (below) yesterday in a research which we find interesting; it shows the employment index (in orange) from the ISM non-mfg survey overlaid with the NFP data (in purple). Some economists already revised down their estimates for tomorrow even if 150K (market’s expectations) is a disappointing figure for the US economy.  A weaker-than-expected figure will definitely reverse the trend on USDJPY and could potentially impact this week’s ‘market effort’.

(Source: Reuters)