United Kingdom: what a week to close out the quarter

The UK experienced a very turbulent time in terms of financial market volatility last week. At the beginning of the week, the pound fell to record lows against the US dollar, albeit in the early hours of the morning, when European markets weren’t open and liquidity was not at its best. GBPUSD spent the rest of the week recovering from that initial fall but did not recoup all of its losses, and that despite the Bank of England stepping in to support the long end of the gilts market with new money printing. The pound’s inability to rebound to levels back above $1.1340 could pave the way for further losses in Q4, when the economic outlook is likely to get somewhat more tricky.

In terms of the UK’s economic performance, the big release of last week was the final Q2 GDP (Gross Domestic Product) figures. These reported an upward revision to the quarter-on-quarter performance, from a 0.1% contraction to a 0.2% expansion. That was prompted by an upward revision to household spending, government spending and net trade. However, all was not as positive as it first appeared. Revisions to the back data left the UK economy in a worse position after the Q2 figures, with overall output 0.2% below its pre-COVID peak, versus 0.6% above that peak previously. Surely that makes it harder for the Bank of England to argue that the UK economy is running too hot, given that the economy hasn’t even recouped the COVID losses.

There was also some interest news from the M4 money supply figures, which reported annual growth slowing to 3.8% in August from 4.4% in July. Money supply growth has been on a slowing trend for some time and could signal a drop in domestic inflation pressures to come. Nationwide reported a stagnation in house prices in the latest month and sharper than expected slowdown in annual house price growth. 

For this week, I think the markets may well see further signs of improvement, continuing to correct from the volatility of last week, albeit that, as we approach the levels currencies have broken beneath, the pound might struggle to sustain those gains. We’ll wait and see whether the drop in gilt yields and interest rate expectations are sustained, and if equities recover or continue to fall. There are no major UK releases this week that will aid or harm the pound, however the UK Conservative Party conference over the course of this week could still provide some focus for market participants.

Europe: inflation overshoots again, despite French and Spanish Consumer Price Index dropping

Whilst the media focus was on the wild performance of the pound on Monday and the intervention of the Bank of England on Wednesday, there was a sizeable move in European markets also. The euro crashed to fresh multi-decade lows against the US dollar ($0.9536), European bond yields continued to climb sharply over the course of the week, albeit they peaked on Tuesday, and the equity sell-off continued also. There was an announcement from the German government that it stood ready to borrow up to €200bn in order to support consumers and businesses with very high energy bills, albeit the actual increase in borrowing was likely to be far less. 

Meanwhile the big news came from the provisional September consumer price inflation print, which hit 10% year-on-year, and that was a considerable overshoot versus expectations. There were also record lows for some individual country measures of consumer confidence, and a further drop in services confidence for Euroland for September. The overshoot of inflation came despite French and Spanish measures undershooting expectations. That was more than made up for by German and Dutch CPI (Consumer Price Index) figures, the latter of which topped 17% year-on-year! The German government also announced a large-scale energy price intervention, of as much as €200bn, which could put a lid on energy price inflation, but at the same time give the ECB (European Central Bank) a different headache to tackle, in terms of additional fiscal borrowing.

So what does this week hold in store? Final manufacturing and services PMIs (Purchasing Managers’ Indices) should hold no further demons for the currency, and neither should the September Spanish unemployment figures or August French industrial production data. Weakness in German factory orders and industrial production and Euroland retail sales, all for August, could undermine the euro, even though the markets are already braced for a set of poor outturns. There have been some members of the ECB that are warning of a deteriorating outturn for the economy, and that may perhaps further impact on interest rate expectations. 

As for the euro, the recovery against the US dollar was, in my view, unimpressive, and it is notable that the pound found itself stronger against the euro at the end of the week than where it had started. Could we see more euro weakness this week? I wouldn’t rule it out.

United States: waiting on the payrolls with the Fed in no mood to slacken the tightening pace

Did we really learn much from last week in terms of the US’s economic performance? The simple answer is no. The releases were pointed to confirmation of a technical recession, albeit one that still recorded an expansion in consumption expenditure. There were further signs of trouble for the US housing market, though bizarrely new home sales increased sharply, and equity markets continued to drop as the outlook for earnings deteriorated both at home and overseas. 

Despite this, the Federal Reserve members that spoke over the course of the week were overwhelmingly in favour of keeping up the pace of monetary tightening. However, there are some cracks appearing, with a few members of FOMC (Federal Open Market Committee) suggesting that the deterioration in some sectors of the US economy and the selloff in equities, could be sufficient reason to slow down the pace of tightening, given that the Federal Reserve is rapidly approaching neutral rates. The majority though are still led by hawks such as St Louis Fed President Bullard, who remains a cheerleader for getting to and above neutral as fast as possible. I doubt such a path for US interest rates will leave the economy or financial conditions more stable in the medium to longer term.

This week, the attention is on the US non-farm payrolls data for September. Expectations are that the net growth in employment will remain solid, albeit there may be further signs of problems in terms of labour force participation. Figures released in the run up to the payrolls release could point to higher rates of layoffs and additional challenges for the housing market. As such, the signals are still pointing towards a worsening economic outlook, and that might play positively in terms of the US dollar in the coming weeks, in my view.

It will be worthwhile keeping an eye on how the US dollar trades against the yen and renminbi as much as the other majors such as euro and pound. If there are signs of renewed strength against these Far East currencies, this could pre-empt a more general re-appreciation of the USD, in my view.

Central banks: Hungary hikes by more but signals a pause; hawkish risks from most central banks this week

Last week’s central bank meetings saw a mixed bag of results. The central bank of Hungary hiked interest rates to 13%, more than was expected, but then signalled that they would be pausing the rate hiking cycle until Q2 2023. Concerns over a weakening economic outlook and some signals of slowing inflation prompted the move, but the forint fell in the aftermath of the central bank’s decision, reaching all time and multi decade highs against a range of major currencies. There is still room for further falls in the HUF’s value as risk appetite continues to deteriorate. The Bank of Thailand hiked by a further 25 basis points to 1%, the Czech Republic left interest rates on hold at 7% as expected, and the Mexican central bank hiked rates 75 basis points to 9.25%, and warned of more hikes to come. Economic outlooks are worsening, and yet central banks remain focused on the inflation fight, whatever the cost. 

For this week there are a plethora of interest rate decisions. Key amongst these are what the RBA (Reserve Bank of Australia) and RBNZ (Reserve Bank of New Zealand) do, and then what the NBP (National Bank of Poland) does. The RBA and RBNZ are likely to hike by 25 and 50 basis points respectively, with the Australian economy showing signs of cooling sharply, and signs that the New Zealand housing market might be going the same way as the Australian.  As for the National Bank of Poland, it appears to be closer to the peak in interest rates than in Euroland, and a drop in wages and a signs of slowdown in the economy offer additional reasons for the NBP to tread more carefully with a 25 basis point hike, although a 50bps hike cannot be ruled out.

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