Sterling edged higher as traders cut bets on jumbo UK hike

Reuters: The pound Sterling edged higher on Friday but hovered near two-week lows after a string of central bank decisions this week reinforced expectations that the Bank of England will not deliver another jumbo rate hike next week.

BRITISH POUND STERLING EDGED HIGHER

Sterling was last up 0.1% against the dollar at 41.2813 and up 0.2% against the euro at 85.58 pence. Against the yen, sterling fell earlier by as much as 1.1% to its lowest in over a month, after the Bank of Japan said it would make its yield curve control policy more flexible, which investors initially took as a sign the central bank might be edging towards a shift in its ultra-loose monetary policy. The sharp rally in the yen reversed, leaving sterling up 0.2% on the day at 178.77 yen.

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The BoE meets on Aug 3 and, right now, traders are leaning more towards a rate increase of 25 basis points, but still see a 25% chance of another half-point rise. “The pound is struggling to book gains amid diminishing expectations that the Bank of England will be able to continue hiking rates aggressively,” City Index strategist Fiona Cincotta said. Investors are still betting heavily on a stronger pound and hold their most valuable bullish bet on sterling since 2014. But interest-rate differentials, which have been one of the major upward drivers for sterling this year, have eroded this month, as the likelihood of a rise in the UK to beyond 6% from 5% right now, has diminished in line with data that has shown inflation is cooling and parts of the economy are slowing.

As a result, the premium of two-year gilt yields , which respond the most to changes in rate expectations, over two-year Treasury yields has collapsed to almost zero this month, from a multi-year high of around 45 basis points. The Fed this week left open the possibility of more rate increases and excluded easing financial conditions anytime soon, which in theory supports the dollar. European Central Bank President Christine Lagarde on Thursday signalled that she did not believe there was much more ground to cover in terms of rate hikes and that any decisions on policy would depend on incoming data. The pound is now heading for a weekly gain of 1.1% against the euro, its largest this year.

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U.S. DOLLAR

Reuters: The yen had its most volatile trading session in months on Friday after the Bank of Japan tweaked its yield curve control policy, leaving investors wondering if an eventual shift in its massive stimulus program is approaching. Whipsawing as traders digested the decision, the Japanese yen weakened 1.13% versus the greenback and was last at 141.05 per dollar in the New York afternoon session. The BOJ is offering to buy 10-year Japanese government bonds at 1.0% and is keeping its short-term interest rate at minus 0.1% and the 10-year government bond yield around 0%. “This is a first step in moving to a tightening in overall monetary policy settings,” said Karl Schamotta, chief market strategist, at Corpay in Toronto. “It does acknowledge that Japan is gradually escaping its inflation trap, and we are seeing signs that the Bank of Japan is going to pull back on its accommodative monetary policy settings in the months and years ahead.”

Schamotta added that the prospect of an increase in yields in Japan is weighing on global yields by suggesting that Japanese investors might keep more money at home, as opposed to redeploying it into government bond markets overseas. Meanwhile, the dollar fell against a basket of its major peers as investors largely shrugged off new data showing inflation slowing as they continue to sort through multiple central bank decisions this week to understand the outlook for monetary policy. U.S. annual inflation in June increased by the smallest amount in more than two years, with underlying price pressures moderating. If the trend continues, it could push the Federal Reserve closer to ending its fastest interest rate hiking cycle since the 1980s.

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Inflation slowed considerably in the 12 months to June, with the personal consumption expenditures index advancing 3.0%, the smallest annual gain since March 2021, the Commerce Department said on Friday. The dollar index fell 0.049% to 101.630, while the euro rose 0.42% to $1.1019. “The focus is back on growth and how much growth the U.S. economy can sustain without inflation ticking higher again,” said Adam Button, chief currency analyst at ForexLive in Toronto. “There’s a great deal of uncertainty about where inflation will ultimately land and what the Federal Reserve will tolerate. Right now, the market is taking it one data point at a time.”

Earlier this week, the Fed and the European Central Bank announced interest-rate hikes, as expected. The ECB raised the possibility of a pause in September as inflation pressures show tentative signs of easing with recession worries mounting. The Fed left the door open to more rate hikes, though Fed Chair Jerome Powell gave few hints about the September meeting. The Fed is having to balance its fight against inflation with an economy that is showing signs of slowing, but is still growing faster than expected and with a robust labour market. Sterling was last trading at $1.2854, up 0.48%. In cryptocurrencies, bitcoin last rose 0.56% to $29,302.02 while Ethereum , last rose 0.88% to $1,874.59.

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SOUTH AFRICAN RAND

Reuters: The South African rand posted strong gains on Friday afternoon, on buoyant risk appetite whetted by the prospect that global interest rates could be nearing their peak. At 1510 GMT the rand was trading at 17.6250 against the dollar, about 1.2% stronger than its previous close after earlier trading up as much as 1.5%. “With major central banks expected to end their rate hikes and the global economy remaining resilient, the rand could be set for further gains ahead,” said Lloyd Miller, co-head of financial markets at ETM Analytics. “South African bonds are trading at attractive levels to foreigners and as inflows into the bond market improve, the rand will continue to strengthen.”

The U.S. Federal Reserve raised rates as expected on Wednesday, but some investors expect that to be the last increase in its hiking cycle. The South African Reserve Bank kept rates on hold last week after 10 hikes in a row. Also supporting the rand on Friday was a weaker dollar on global markets and data showing South Africa recorded a budget surplus in June. The rand has gained more than 6% against the greenback this month, with analysts citing foreign buying of government bonds and a commitment by Chinese policymakers to support their economy among drivers.

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On the Johannesburg Stock Exchange, the blue-chip Top-40 index closed up about 0.3%. South Africa’s benchmark 2030 government bond firmed on Friday, as the yield fell 3 basis points to 10.185%.

GLOBAL MARKETS

Reuters: Asian shares were trying to end the month on a firm note on Monday in a week littered with major economic releases, central bank meetings and earnings updates from mega caps Amazon and Apple, though rising Japanese bond yields posed a risk. China surveys were mixed with factory activity just pipping forecasts but services disappointing, though both merely reinforced wagers that Beijing would have to act at some point. China’s State Council on Monday did issue measures to restore and expand consumption in the automobile, real estate and services sector, though this was a long way from the massive fiscal spending markets have been counting on.

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Blue chips seemed unperturbed and added 0.6%, bringing gains for July to 4.5%. MSCI’s broadest index of Asia-Pacific shares outside Japan climbed 0.5%, having gained 5.2% so far in July to reach a five-month high. The initial impetus for markets was positive following Friday’s U.S. data showing an easing in wage costs and core inflation, which fuelled hopes the Federal Reserve was done tightening. “The data surprises bolster confidence that global core inflation – ex. China – will fall sharply and set the stage for a developed market central policy pause and emerging market easing even if growth remains firm,” said Bruce Kasman, head of economic research at JPMorgan.

Figures due this week include the U.S. ISM surveys on manufacturing and services, the July payrolls report and European inflation. The Bank of England is widely expected to raise rates by at least a quarter point, but markets are more divided on whether the Reserve Bank of Australia will hike or stay on hold. Almost 30% of the S&P 500 report results this week and so far, earnings have been good enough to see the index extend its rally to 10% since the start of June. S&P 500 futures dipped 0.1% on Monday, but the index was still up 2.9% for July, while Nasdaq futures dipped 0.2%. EUROSTOXX 50 futures and FTSE futures both eased 0.4%. Apple Inc and Amazon.com both report on Thursday, while other well-known names with results due include Western Digital Corp, Caterpillar Inc, Starbucks Corp, and Advanced Micro Devices.

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Japan’s Nikkei rose 1.2% to re-take the 33,000 level and nudge closer to its recent three-decade peak. Investors are still pondering the implications of Friday’s shock decision by the Bank of Japan to lift the lid on bond yields, in a step away from its ultra-easy policies. Analysts at BofA estimate the BOJ’s bond buying added $1.3 trillion to global liquidity in the past 18 months and provided a low floor for global rates, so any sustained rise in Japanese government bond yields could ripple though other bond markets. Japanese 10-year yields climbed further to 0.6% on Monday, and toward the new cap of 1.0%. That also put upward pressure on Treasury yields, where the 10-year rose 3 basis points to 3.99%.

While the yen had initially rallied on the BOJ move, it soon reversed course as investors still seemed happy to run carry trades, or yen-funded positions in higher-yielding currencies. “Friday’s action might best be viewed as an attempt to head off a fresh wave of yen-weakening carry trade activity, by at least ceasing to resist pressure for 10-year yields to rise above 0.5%,” said Ray Attrill, head of FX strategy at National Australia Bank. “Friday’s actions do, though, fail to provide a catalyst for a secular reversal of yen weakness.” The yen was again under pressure on Monday as the dollar pushed up to 141.87 yen , a long way from Friday’s brief low of 138.05.

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The euro had also recovered from its initial pullback to stand at 156.18 yen , while steadying on the dollar at $1.1010 after some wild swings last week. In commodities, gold was off a shade at $1,955 an ounce , leaving it 1.8% higher for the month so far. Oil prices took a breather, having risen for five weeks in a row as production cuts by OPEC+ tightened supply. Goldman Sachs on Sunday revised up its global oil demand forecast for the year while sticking to its 12-month Brent price projection of $93 per barrel. Brent was off 59 cents at $84.40 a barrel, while U.S. crude eased 31 cents to $80.27.

Published by the Mercury Team on 31 July 2023

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