Ranges hold in major FX pairs for now, despite challenges to both sides recently; risks of a breakout intensify

The FX markets have been testing the resilience of both buyers and sellers over the past few weeks, with both sides of recent ranges tested but no decisive breaks having yet been made. GBPUSD appears to be stuck in a $1.2550 – $1.2840 range, while EURUSD has tested both $1.0760 and $1.1070 within the last month with no conviction to break either higher or lower. 

In GBPEUR the ranges have been even smaller between €1.1530 and €1.1775, as the GBP and EUR have gained or lost ground to the USD simultaneously. The frequency with which the market is oscillating between low and high and back again appears to be increasing in all three major currency pairs, suggesting that a breakout is likely, but to what side?

I’m still of the view that the US dollar will make gains as we head into the end of the year. There are several reasons for this, but the top three are as follows: 

  1. The markets are overestimating the scale of additional UK and EUR interest rate hikes relative to the US
  2. The weakening in economic activity indicators appears to be larger in the UK and Euroland versus the US
  3. The geopolitical risks and threats to global risk appetite (weaker equities) appears to favour the US dollar based on previous observation.

Downside risks on economic activity likely to be increasing, reducing the need for additional monetary tightening

Across all three major economies (US, Euroland and UK), the most recent run of data and survey releases points to a slowdown in activity, and in some cases indications that a fresh recession might be underway. The weakness of global economic activity also appears to be showing in Asia, where recent Chinese PMI (Purchasing Managers’ Index) survey evidence has pointed to a contraction. 

The question of the need for more monetary tightening is further informed by what appears to be an acceleration in businesses getting into financial difficulty, closing voluntarily or being forced to shut their doors. High interest rates are increasingly being indicated as a major source of strife for businesses already faced with cost challenges and greater uncertainty over order books.

In short, the work of major central banks is done, in my view, and further tightening from here could worsen the economic outlook without materially improving the inflation outlook. 

Central banks looking lower on interest rates as the hard work is done

For emerging market central banks, and some non-major developed central banks, this week should be about further demonstrating that enough is enough, in terms of monetary tightening. None of those set to announce should be readying themselves for more hikes, and already announced this week, the Bank of Israel has left the base rate at 4.75%.

The Reserve Bank of Australia, National Bank of Poland, Bank of Canada and Bank Negara Malaysia (BNM) are all expected to leave interest rates on hold, whilst the Banco Central de Chile is expected to cut the key official interest rate by 100 basis points to 9.25%. 

I suspect there will be more central banks cutting interest rates over the coming months, with concerns over economic weakness likely to outweigh any residual inflation fears.

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