16 May 2022: Sterling in oversold condition

Sterling in oversold condition

16th May: Highlights

  • Double-digit inflation now a probable
  • Commentators in a quandary about downturn
  • GDP forecast cut; inflation set to average 6.2% in 2022

Government sees response to downturn as correct

Recent data releases and Government actions. Or lack thereof mean that it is now almost certain that headline inflation will reach 10% in the coming months.

It may very well be that having reached that level, prices will begin to stabilize and begin to fall as the economy falters and falls into a recession.

The most pressing questions are when will the economy fall into contraction and how long will the recessions last. It is possible that the slowdown has already started and the third quarter will add confirmation.

As the fourth quarter beings, the expected second increase in the energy cap this year will lead to an extremely tough winter.

There is also the possibility of a trade war between the UK and European Union as the Government grapples with the outcome of last week’s election in Northern Ireland, which placed Republicans in power for the first time and led Unionists to refuse to agree to the recommencement of the Power Sharing Agreement Unless there are changes to the Protocol under which shipments between the mainland and Northern Ireland are handled.

The EU has already said it will not make any changes to the protocol which could lead Westminster to act unilaterally.

Business Minister Kwasi Kwarteng appeared on media outlets yesterday and commented that he didn’t see a trade war as likely despite Brussels threats.

He went on to say that it has been six years since the Brexit vote and despite several threats from Brussels during negotiations, they have not followed through at all on any of those threats.

Kwarteng went on to imply that a trade war is not in the EU’s best interests, given the parlous state of its economy.

The pound continued to suffer last week against a dollar which continues to make ground.

Technically, Sterling is oversold and several banks see the fall as overdone. Traders appeared to have the bit between their teeth to push the pound to the 1.20 level versus the Greenback, but if that is to happen there will need to be a correction that allows shorts to be liquidated and reinstated at higher levels.

The pound fell to a low of 1.2155, but recovered to close at 1.2262.

This week, Andrew Bailey will testify to the Treasury Committee in the House of Commons on the current state of the economy and the Banks’ plans.

Employment data will be released on Tuesday, with inflation on Wednesday.

It is expected that headline inflation will have risen to over 9%. This will add to speculation about what the eventual top will be.

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Bad news coming from all angles

The University of Michigan survey on Consumer Sentiment fell from 65.2 in April to 59.1 in the current month as the economy was subjected to factors that pushed commentators towards predicting a significant but not yet a recession.

Although the economy is weakening and the Fed is tightening monetary policy at an alarming rate for some, the FOMC retains the confidence of the country in General, and Wall Street in particular.

Rising inflation, tightening interest rates that are leading to higher mortgage rates and a perception of financial market instability are the most frequently quoted reasons.

There is little belief that the conflict in Ukraine and the rise in the wholesale price of energy are going to have a long-term effect, since the belief remains that Russia has little ability to retaliate.

One other issue is the continued issue of supply chains that are being exacerbated by the continued issue of Covid1-19 that has returned to several areas of China.

There have been calls across both Houses for the American Economy to be decoupled from China.

This is difficult to perceive since it is doubtful that the American consumer would want to pay the prices expected by U.S. manufacturers were production to be returned to the U.S. where just about every item of the process would cost more.

Economists are beginning to doubt that current Fed Actions can lead to a soft landing, as Jerome Powell has predicted recently.

With inflation showing a very early sign that it may be moderating and producer prices also lower in April, it may be that the Fed’s aggressive tightening schedule may become considered a little overdone.

As if being found as a newly found stick with which to beat the Central bank, the Index of Economic Optimism, which fell from 45.5 to 41.2 in April, is being cited as a warning that support for the Fed’s Actions is waning. Unfortunately, no one can find any data from previous months/ years which backs this theory.

In contrast, business optimism remained unchanged from an already solid reading of 93.2.

The dollar index continues to garner support, although its recent meteoric rise appears to be slowing.

Last week, it reached a high of 1005.01, but having reached most analyst’s target, it fell back to close at 104.46.

This week, Data for retail sales, industrial production and capacity utilization will be released, as well as construction data which may illustrate the effect of higher rates of the housing sector.

Industrial Production falling

The European Union still believes that an across-the-board ban on imports of Russian energy can still be achieved. One question that the European Commission appears to be unable to answer is; if the bank comes in within six months, when did the clock start ticking?

Germany believes that it may be able to achieve the target by the end of the year, (seven and a half months from today), but Olaf Scholz may not wish to plunge his nation into what would be a severe recession and may decide to cut down by not stop completely.

The European Union cut its own forecast for 2022 GDP last week, from 4% to 2.7% while next year’s forecast is for growth of 2.3% next years versus a previous prediction of 2.7%

It seems that the economists at the ECB still see no recession in the region. This appears to be highly improbable.

Inflation is likely to be higher this year as well. The previous prediction was for prices to rise by 6.1% from up from a rate of 3.5 that was previously indicated.

Globally, the IMF is forecasting a significant slowdown, so it doesn’t make sense for the bloc, built on manufacturing, trade and exports to remain so relatively bullish.

There is a growing clamour amongst ECB Governing Council Members for a rate hike to be confirmed for July. Even the ECB’s President, Cristine Lagarde is more willing to discuss such action now, ECB vice President Luis de Guindos commented that he doesn’t want to get sucked into the debate on when the hike will happen. Having used the term when rather than if appears to place him, according to observers, in the July Camp.

Although there remains very little reason to buy the single currency, the rate of its fall towards parity against the dollar. has slowed a little.

This is, in the main, due to traders failing to justify further dollar strength. Last week the euro fell to a low of 1.0349 but closed at 1.0412.

This week, employment data and Q1 GDP data will be revealed. While Q1 is still expected to see an expansion of 0.2% QoQ the second quarter will almost certainly register a contraction.

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.”