Pound fell against the US Dollar after surge in first half of the year

Reuters: The pound fell against the dollar on Monday as the U.S. currency rebounded from a tumble late the previous week, while traders continued to grapple with what expectations of several more Bank of England rate hikes mean for the British currency.

BRITISH POUND FELL AGAINST THE DOLLAR

Sterling was last down 0.18% at $1.2669, giving back some its 0.63% Friday gain after U.S. inflation data came in softer than expected, and sent the greenback lower across the board. The pound was steady against the euro at 85.94 pence. It ranked among the best performing currencies against the dollar in the first half of the year, gaining 4.8%, thanks to anticipation British interest rates would rise by more than many originally expected and stay higher for longer.

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But analysts are now starting to wonder whether the positive impact of higher rates for the British currency has run its course. “The outlook for sterling is a battle between relatively high yields and poor growth prospects,” said Paul Robson, head of G10 FX strategy at NatWest, in a note. The pound is expected to maintain a large yield premium over the euro for the next three years, and increase its premium over the dollar, Robson said, but “the extent to which this supports sterling will depend on the collateral damage it causes on the UK economy.” British government borrowing costs, as reflected by two-year bond yields, have soared this year. Two-year gilts yield around 5.3%, having risen by 160 basis points so far this year, compared with a 53-bp rise in two-year Treasuries and a 56-bp rise in German Schatz yields.

It costs the UK government more to borrow over two years than it does the governments of Italy or Greece. The rise in gilt yields is underpinned by expectations of further tightening by the Bank of England, which raised interest rates by half a point two weeks ago to 5%, and is expected by markets to deliver an identical increase when it meets in early August. Money markets show traders believe UK rates will now not peak until almost mid-2024, when they could rise to as much as 6.20%. A month ago, the expectation was for a peak, or terminal, rate of around 5.3% by the end of this year, with the first rate cut following a few months later, but as things stand right now, traders expect no rate cuts until August next year.

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“This big jump in UK yields has seen the pound outperform against its peers, rising by 5% against the US dollar, and by as much as 13.5% against the Japanese yen,” CMC Markets market strategist Michael Hewson said. “While financial markets try to determine how many more rate hikes are coming, the next question is how long they will have to stay at current levels, and what happens when the deflation that is already being seen in the PPI numbers starts to manifest itself in the core inflation numbers,” he said. There has been a sharp drop-off in wholesale input prices that make up the producer price index to an annual rate of 0.5% from a peak of 24.3% last June.

Speculators now hold the largest bullish position in sterling since April 2018, when holdings were at their highest since 2014, two years before the Brexit referendum. Weekly data from the Commodity Futures Trading Commission on Friday showed net non-commercial market players held a long position in sterling worth $4.142 billion. Simmering in the background for the pound is the crisis at Thames Water, Britain’s biggest water supplier. The government is considering taking the company into temporary state ownership, as it struggles with a 14-billion pound ($17.7 billion) debt pile.

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U.S. DOLLAR

Reuters: The dollar was little changed on Monday against a basket of major trading currencies and gained against a yen that’s under intervention watch after the Japanese finance minister warned last week of excessive moves in the currency market. The dollar initially weakened on news of U.S. manufacturing slumping further in June to levels last seen when the economy was reeling from the initial wave of the COVID-19 pandemic. The Institute for Supply Management said its manufacturing PMI dropped to 46.0 from 46.9 in May, the lowest reading since May 2020. It marked the eighth straight month that the PMI has been below the 50 threshold indicating contraction. “The key on the ISM was the prices paid, which was much weaker than expected,” said Marc Chandler, chief market strategist at Bannockburn Global Forex in New York. “The ISM saw the dollar pare its earlier gains,” he said.

The ISM survey was consistent with an economy in recession as price pressures at the factory gate continued to deflate, suggesting U.S. inflation is coming under control. But other data such as nonfarm payrolls, first-time applications for unemployment benefits and housing starts, suggest the U.S. economy continues to grow, a concern for those who see inflation again picking up at the end of summer. “The bottom for this inflation process is going to be put in place next week, then we’re probably going to see prices go up,” said Ed Moya, senior market analyst at OANDA in New York, referring to the release of the consumer price index on July 12. “This market was so fixated that these pricing directions were going to be one-way, well it’s going to be in for a rude awakening.”

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The yield on interest rate-sensitive two-year Treasuries at first fell on the news, before later heading higher, as did the dollar. The two-year hit an almost four-month high of 4.963%. The ISM survey’s measure of prices paid by manufacturers fell to 41.8 in June from 44.2 the prior month as bottlenecks in the supply chain eased and higher borrowing costs dampened demand. The dollar index , a measure of the U.S. currency against six other currencies, rose 0.039%. The yen fell to near eight-month lows against the dollar as intervention came into sight after Finance Minister Shunichi Suzuki warned on Friday against investors selling the yen too far as it weakened past the threshold of 145 to the dollar.

Japan bought yen in September, its first foray in the market to boost its currency since 1998, after a Bank of Japan decision to maintain ultra-loose policy drove the yen as low as 145 per dollar. It intervened again in October after the yen plunged to a 32-year low of 151.94. The Japanese yen weakened 0.25% versus the greenback to 144.68 per dollar. The euro rebounded after earlier weakening on data showing a slowdown in factory activity in China and the euro zone renewed concerns about economic growth. Fears of a slowdown in the global economy have weighed on the euro after rising for three consecutive quarters.

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A private sector survey on Monday showed China’s factory activity growth slowed in June, with sentiment waning and recruitment cooling as firms grew increasingly concerned about sluggish market conditions. Euro zone manufacturing activity contracted faster than initially thought in June as persistent policy tightening by the European Central Bank squeezed finances. The euro was last up 0.01% to $1.0911. China’s onshore yuan was down slightly at 7.2419 after slipping to near eight-month lows against the dollar at the end of last week.

SOUTH AFRICAN RAND

Reuters: The South African rand strengthened on Monday, recovering some losses incurred last week along with other emerging market currencies. At 1523 GMT, the rand traded at 18.7350 against the dollar, 0.48% higher than its closing level on Friday. The dollar last traded at 102.98, around 0.03% stronger against a basket of global currencies. The rand seemed unperturbed by a local survey on Monday, which showed South African manufacturing activity contracted for the fifth consecutive month in June due to a worsening of business conditions.

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However, analysts warned that the risk-sensitive rand was susceptible to further weakness in the near-term amid hawkish tones by central banks around the world including the Federal Reserve. “The minutes of the last FOMC meeting are due out on Wednesday, and will allow markets to more deeply scrutinise the reasoning of US monetary policy makers, and attempt to glean insight on the likely length of the pause in the cycle,” said Investec analyst Annabel Bishop in a research note.

Shares on the Johannesburg Stock Exchange rose slightly, with both the broader all-share index and the Top-40 index closing around 0.3% higher. South Africa’s benchmark 2030 government bond was slightly stronger, with the yield down 1 basis point to 10.500%.

GLOBAL MARKETS

Reuters: Asian stocks rose on Tuesday afternoon after Australia’s central bank held interest rates steady, which helped ease investor worries about over-tightening of policies by central banks. MSCI’s broadest index of Asia-Pacific shares outside Japan edged up by 0.3% by Tuesday early afternoon, reversing mild losses in the morning. Australian shares added 0.5%. The Reserve Bank of Australia kept its cash rate at 4.10%, saying it wanted more time to assess the impact of past hikes. Signs of constrained global demand amid rate hikes is making central banks nervous, said Gary Ng, senior economist for Asia-Pacific thematic research at Natixis. “Central banks, especially those in the Asia Pacific region, have no choice but to rebalance their hawkish stance,” he said. That less hawkish stance, together with signs that China is pushing to support yuan, is propping up the market, he said.

Matt Simpson, senior market analyst at City Index, said the pause in rate hikes by the Australian central bank “came as a relief to equity bulls”. “The ASX looks determined to tap 7300 this week. But it may need to look for global sentiment to pick up to hold on to recent gains,” he added. Japan’s Nikkei share average fell 0.9% as investors exited some bullish positions after the benchmark index closed at a 33-year high in the previous session. China’s mainland benchmark was flat and Hong Kong’s Hang Seng Index added 0.6%, led by tech companies. U.S. S&P 500 E-mini stock futures were flat in Asian trade. Wall Street stock indexes ended Monday’s shortened session up slightly along with Treasury yields.

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Most of Wall Street was closed for the U.S. Independence Day public holiday on Tuesday. In early European trades, the pan-region Euro Stoxx 50 futures and German DAX futures both edged up by around 0.2%, while FTSE futures were almost flat. Investors are now watching out for a mixed bag of economic data ahead of second-quarter earnings for more trading cues, while uncertainty remains over the U.S. Federal Reserve’s policy path, said Manishi Raychaudhuri, head of Asia Pacific equity research at BNP Paribas. The minutes from the Fed’s last meeting are due later this week, which could provide additional clues on policy direction but also inject some volatility, he said. “If the Fed overtightens and decides to do more rate hikes than twice as the market widely expected, then there’s a concern that the recession may turn out to be deeper than what is being factored in,” Raychaudhuri said.

Geopolitical tensions also persist, he noted, with China’s export controls on minerals adding more uncertainty around global trade relations. In the currency market, the dollar index , which tracks the greenback against six major peers, rose slightly to 102.97. Oil prices held steady on Tuesday, after settling 1% lower on Monday, as markets weighed supply woes from cuts for August by top exporters Saudi Arabia and Russia against economic data that suggested demand was weak. Brent crude was up 0.6% at $75.07 a barrel. U.S. West Texas Intermediate crude also added 0.6% to $70.2.

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The Treasury market is shut Tuesday for Independence Day. On Monday, a widely watched section of the U.S. Treasury yield curve hit its deepest inversion since the high inflation era of Fed Chairman Paul Volcker, reflecting financial markets’ concerns that an extended Fed hiking cycle will tip the U.S. into recession. Gold was slightly higher, with spot gold traded at $1924.09 per ounce.

Published by the Mercury Team on 4 July 2023