Ultimate direction determined by Brexit prospects

The pound is being pulled in various directions by a weaker dollar and stronger euro as traders await clarity over who will be the next leader of the Conservative Party and, ultimately, Prime Minister.

Neither candidate has so far covered themselves with glory. Boris Johnson is being seen as dodging questions over his home life and more importantly how he will deliver Brexit, while Jeremy Hunt is spending more time criticising Johnson than outlining his own policies.

There appears to be little confidence being shown in the pound’s rally versus the dollar as no long positions are being established, with those who have been short at lower levels simply getting out of the way of the avalanche of dollar sellers in the wake of the expectation that rates will be cut in the U.S. It is probable that once the Fed’s plans become clearer, the sellers of Sterling will return.

The fall versus the euro, while possibly more illustrative of the market’s view of the balance of risks facing both economies, could also run out of steam. The long-term target at 1.1000 is now in sight and it is considered unlikely that there will be a concerted effort to break that level without a significant move on Brexit, which won’t be happening before the end of next month once the Leadership ballot has been concluded.

Yesterday, the pound made a high of 1.2767 against the dollar before closing virtually unchanged on the day at 1.2740, while versus it fell to a low of 1.1159, closing at 1.1176.

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Greenback remains under pressure

It is becoming clear that there is a concerted effort in place to weaken the dollar, but the question remains, is the pressure coming from the market in response to last week’s FOMC meeting or is there a more “official” plan being executed?

The market reaction to last week’s announcement is more illustrative of a surprise announcement, for example, had the dollar rallied on the back of a surprisingly hawkish statement.

However, since the words and phrases used by Fed Chairman Jerome Powell were entirely in accordance with market expectation, the dollar’s precipitous fall over the past five daily trading sessions is beginning to look distinctly overdone.

The final cut of Q1 GDP is due for release on Thursday and while it is expected to be unchanged at 3.1% it will be a timely reminder to the market of just how strong the economy has been even if there has been a slowdown in Q2. It will be some weeks before the rate of that slowdown can be confirmed with Q2 GDP not due for release until late next month at the earliest.

Tensions remain between Washington and Iran with a further raft of sanctions targeting individuals in the Iranian hierarchy, while the military build-up in the Gulf continues. The Swiss Franc and gold have both risen in value as safe havens in a time of global uncertainty.

The dollar index made a low of 95.97 yesterday, closing at 97.99. It has continued to fall overnight, so far (05.30BST) making a low of 95.84.

Mixed German data brings further concerns

Data released by the German IFO institute yesterday about the current state of the German economy and the future prospects added to the mixed view of the prospects for the entire Eurozone.

There have been profit warnings now from Lufthansa, Daimler Benz, and chipmaker Siltronic as German business continues to suffer. The demise of diesel vehicles and the scandals that hit Mercedes and engulfed Volkswagen have had long-lasting effects on the wider economy.

While the phasing out of diesel power is environmentally correct, Germany, having acceded to Green Party demands to also end nuclear production of electricity, finds itself ill-prepared for the future.

The IFO data released yesterday showed a greater than expected fall in expectations for the economy, while the business climate and current conditions were virtually unchanged.

The recent rally in the value of the euro is unlikely to last once traders refocus on the Eurozone economy following their over-zealous reaction to the possibility of rate cuts in the U.S. and the euro may be close to a short term high.

Brexit is also a major consideration for the single currency, the reaction to which has, so far, not really been fully priced in. The effect on German industry, car manufacture in particular, may end up petitioning Chancellor Merkel to act should a no-deal Brexit become more likely.

Yesterday, the euro reached highs of 1.1404 and 1.1159 versus the dollar and pound, closing at 1.1398 and 1.1176.