15 July 2019: Sterling recovery to be brief

Sterling recovery to be brief

July 15th: Highlights

  • Pound driven by greenback as it awaits election result
  • Market expectations growing stronger
  • Italy’s debt “fantasy agreement helps avoid fine

Data unlikely to have a lasting effect

The release of employment, inflation and retail sales data this week is unlikely to have a significant effect on the pound as traders await the outcome of the ballot on who will be the next leader of the Conservative Party.

Tomorrow’s jobs report will show that the unemployment rate was unchanged in June at 3.8% and wages grew at a healthy 3.2%. This is likely to be “as good as it gets” since the economy is unlikely to be able to create further improvements in job creation with the spectre of Brexit hanging over business investment.

The rally that saw the pound reach a high versus the dollar of 1.2580 on Friday is solely due to the expectation of a cut in short-term interest rates in the U.S. and will be quickly reversed should, as expected, Boris Johnson become the new Prime Minister.

The pound has fallen by 3.7% over the past three months and with the Bank of England appearing to reverse its previous guidance of a rate hike later in the year, it is hard to see where any support can be derived. The rate of depreciation is only going to speed up and with markets “thinning out” as the holiday season begins, liquidity could become an issue creating an increase in volatility.

Last week the pound made a low of 1.2439 versus the dollar and continued its fall versus the single currency. It reached a low of 1.1088, closing at 1.1158.

Considering your next transfer? Log in to compare live quotes today.

“Selling the rumour” sees the dollar lose ground

The market is in no doubt at all that the Federal Reserve will cut interest rates at its meeting at the end of the month. Traders have therefore done what traders always do and reacted in advance to the official announcement. The term coined in financial circles is “selling (or buying) the rumour and buying (or selling) the fact.

This leads to large positions being built up which leads to a reversal as soon as the news becomes official. In the current scenario, that could see the dollar index recover unless there is significant advance guidance from Chairman Jerome Powell following the announcement about the future path of interest rates.

Given what has been said by FOMC members over the past few weeks and the fact that there is continued discussion about just how much rates need to be cut to see economic growth at close to 3%, the market could easily be disappointed.

There have been several mixed messages from Powell in the period since the last FOMC meeting and even the minutes of that meeting were more than a little ambiguous.

The Fed is under pressure to cut rates but the reasons for the pressure are as much political as they are to do with the economy. To maintain its independence, following a 25bp cut this month, the Fed may very well signal a return to data-dependency which would mean no further cut until Q4. This would give analysts time to digest the effect of a single move.

Last week the dollar index remained pressured, reaching a low of 96.79 and closing just a few pips higher. During the week it reversed 50% of the gain made following a stronger than expected employment report.

Retail sales data, together with several regional activity reports, will be released this week but rate cut fever will remain the biggest driver for the dollar.

Rome avoids a fine over budget “anarchy”

Italy remains a thorn in the side of Brussels given the unpredictability of its Government. There was relief from all sides when it was decided that no fine would be levied for the overshoot of its 2019 budget. Rome had announced a budget that raised its deficit to 2.4% this year but after negotiation with Brussels that was lowered to 2.04%.

However, the deficit is going to be closer to the original number.

The breaking of rules which are set at an arbitrary level is not the major issue since Italy’s nationalist government will continue to do what it considers best for the country and Brussels, trying to deal with the effects on its own budget of Brexit, is inclined to “turn a blind eye”

Italy will be in a vicious circle as its budget deficit grows. It will need to borrow more which will push its debt closer to 140% of GDP in an economy which is barely growing. Debt currently stands at 131.2% of GDP.

Rumours continue to swirl about the issue of a domestic currency with the implicit guarantee of the Government. This would technically be acceptable under the rules governing the euro but would certainly be outside the intended purpose of the single currency.

The current political situation in Italy is somewhat fluid with one of the partners in the coalition gaining ground in recent elections while the other fell away. It is expected that the 2020 budget will shatter the 3% level which is likely to bring the more radical views of “Il Capitano” Matteo Salvini, leader of Five Star, into direct conflict with Brussels.

Meanwhile, the single currency continues to fail to find any growth in the Eurozone economy. Data is weak without being disastrous while inflation stubbornly refuses to move closer to the ECB’s 2% target.

The euro made a low of 1.1193 last week but improved to close at 1.1269 as the dollar weakened.

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”