Daily Market Brief 20 July 2017

Sterling little changed as Rate Hopes Fade

July 20th: Highlights

  • MPC likely to remain on hold
  • ECB meeting to manage expectations
  • EUR & GBP hang on to gains

MPC likely to confirm “data driven” stance

Market analysts have spent an inordinate amount of time forming ideas about how members of the MPC will vote at their next meeting which is still two weeks away. In the end, as is often the case, the decision will be data driven giving little room for interpretation or opinion.

This week’s inflation data following last week’s employment report have pretty much made up the markets mind that the Bank of England will remain on hold. Governor Mark Carney has faced criticism from MPs about the Bank’s tolerance of an inflation rate that has remained significantly above the Government’s target. He has been steadfast in his view that unique circumstances are driving the U.K. economy which have ultimately led to higher inflation and lower growth.

The rate cut following last year’s Brexit referendum was clearly a knee jerk reaction which, while not the major reason for Sterling’s fall, probably contributed more as an indication of the Bank’s concern than the material fact of a widening of interest rate differentials.

Sterling remains well supported against the dollar holding above the 1.3000 level. The Euro has been rejected twice on approach to 0.8900 but depending on the outcome of today’s ECB meeting that level could be broken later.

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Draghi to face press as Euro economy continues to improve

There has been an imperceptible, yet growing, view among market participants that the Eurozone economy is on the verge of emerging from its shell and becoming the major force it has always been expected to be. As an experiment, there was far too much expectation put on the ECB in its early days under first Duisenberg, then Trichet. The global financial crisis which brought about the debt crisis meant that survival above all else was all that mattered.

Now ECB President Mario Draghi will, in the remaining two years of his tenure, be able to forge policies that pertain more to future policy than the firefighting he has had to face up to now.

Sr. Draghi will leave his position in 2019, just as Brexit reaches a conclusion, and having had a Dutch, French and now Italian President, there is pressure for a German to take the role. Closer ties between the ECB and Bundesbank may not favour the smaller nations but it will prove difficult to resist.

Having languished close to parity against the dollar which was basking in the glow of Trump’s victory, the Euro has prospered even as the interest rate differential has grown. The 1.2000 level is a realistic target despite currency futures data showing near record long Euro positions.

Currency market ranges narrow as liquidity remains high

The third quarter of the year is the “holiday quarter” when traders take vacations and the market reverts to a “defensive” mode where provision of liquidity often dries up and fresh positioning is put on hold. Trading in the Euro, in particular, has become so automated with very little manual intervention that spreads are constantly under pressure.

Sterling seems to be the major sufferer among the major currencies when liquidity dries up having had a few “flash crashes” in the last year or so.

Overall, the market is becoming more efficient having taken a giant leap from voice broking to technological advancement. The reaction to market data even when it provides a surprise is often muted.

A case in point is the reaction to the U.K. inflation data on Tuesday. In the past, particularly as it was Sterling, a move of up to two hundred points wouldn’t have been unusual dependent upon the markets positioning leading into the data. Now a thirty or fifty-point reaction is viewed as a newsworthy event. Traders are starting to use Average Daily Range (ADR) to set their stop losses. Such efficiencies can only be good for “market users” as they see a more reliable pricing structure emerge that doesn’t move on the whim of human intervention.

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.”