Westminster Drama To Dominate Pound Vs Euro, Dollar

21.10.22: Westminster Drama Continues, but US Bond-Market Moves Crucial for Sterling and Euro Moves Against and Dollar

UK political drama will continue to be the dominant media focus, but the change in fiscal stance has already resulted in a sharp decline in the risk premium on UK assets, limiting scope for a major Sterling repricing on domestic political grounds.

In this context, the global market trends are likely to have a greater underlying impact with Federal Reserve policies and US yields will be extremely important.

The US 10-year yield has increased sharply to fresh 14-year highs and high yields will cause important stresses in global markets.

The dollar will tend to gain further net support while high yields will also tend to undermine equities, boost defensive dollar demand and limit support for risk-sensitive currencies.

If US yields continue to increase, there will be an increased risk that equities will slide.

Any hint of a U-Turn by the Fed would have a major impact on global currency-market dynamics.

Pound US Dollar Exchange Rate Outlook

Just after the New York open on Thursday, Prime Minister Truss announced that she was resigning as Conservative Party leader due to the inability to deliver on the economic mandate.

The Pound to Dollar (GBP/USD) exchange rate had rallied into the announcement and posted further gains with a peak above 1.1300 on hopes that stability can be restored.

GBP/USD was unable to sustain the gains with support undermined by an underlying lack of confidence in UK fundamentals and it traded around 1.1180 on Friday.

Weaker global risk appetite also sapped support for the currency.

Political developments will be watched very closely as potential candidates look to decide whether to run and secure the high bar of 100 nominations to stand.

Sterling would likely gain some support if a unity candidate emerges.

Global market moves will also be extremely important for Sterling moves, especially given the impact of risk appetite.

This is particularly important as UK yield expectations have dipped lower following the comments from Bank of England Deputy Governor Broadbent that market interest rate expectations are too high.

The overall fiscal U-turn has, however, substantially lessened the potential for aggressive Sterling selling with a greater risk of a grind lower amid weak fundamentals.

The latest retail sales and borrowing data illustrated UK vulnerability with a 1.7% slide in sales and a wider than expected budget deficit.

Overall, GBP/USD is unlikely to make any headway unless there is a net improvement in risk appetite and a recovery in equities.

Euro (EUR) Exchange Rates Today

The Euro advanced around Thursday’s European open with a rebound in European currencies and the Euro to Dollar (EUR/USD) exchange rate posted highs just below 0.9850.

EUR/USD failed to hold the gains and dipped back below 0.9800 as the dollar posted a renewed advance and it traded around 0.9770 on Friday.

Overall confidence in the Euro-Zone economy remains fragile, but there is likely to be some caution over Euro selling ahead of next week’s ECB policy decision.

ING expects the ECB will increase rates by 75 basis points, but doubts the Euro will gain much support from.

It notes that overall yield spreads will still be negative for the Euro while there is underlying pessimism over the Euro-Zone outlook and the Fed is maintaining a hawkish stance.

It adds; “Attempts by the ECB to lift the euro through more tightening should still be unsuccessful in the near term and we continue to target 0.92 as a year-end value in EUR/USD, with any upside correction proving only temporary.”

US Dollar (USD) Exchange Rates Outlook

The US Philadelphia Fed manufacturing index edged higher to -8.7 for October from -9.9 previously, but was weaker than consensus forecasts and four of the last five readings have been in contraction territory. The prices paid and prices received components posted stronger gains on the month.

Companies were notably less optimistic on the month while inflation pressures are expected to moderate.

Federal Reserve speakers have maintained a hawkish policy stance with no signs that there is any pivot from plans to keep raising interest rates over the next few months.

There were further sharp losses for Treasuries with the 10-year yield posting a further strong advance to fresh 14-year highs above 4.25%

Higher US yields were a key element in supporting the dollar.

Yield trends will remain a key element and provide further underlying dollar support in the short term, especially if equities are subjected to further selling.

Other Currencies

The Japanese yen has remained under underlying pressure, primarily due to the impact of extremely low domestic yields.

The Pound to Yen (GBP/JPY) exchange rate jumped to highs at 169.70 before a sharp retreat to 168.25.

The Pound to Swiss franc (GBP/CHF) exchange rate also jumped to 1.1340 before a slide to 1.1255.

Overall risk conditions remained a key element during the day.

The Pound to Australian dollar (GBP/AUD) exchange rate dipped to 1-week lows below 1.7770 before a recovery to 1.7880.

The New Zealand trade data was better than expected, but the Pound to New Zealand dollar (GBP/NZD) exchange rate found support at 1.9650 and recovered to near 1.9800.

The Day Ahead

There are only limited data releases on Friday and no major speeches due from Federal Reserve speakers.

Trends in bond markets will be extremely important during the day, especially given the impact on Wall Street and global stock exchanges.

Markets will be on alert for Japanese intervention to support the yen with any aggressive intervention likely to trigger a sharp dollar retreat.

There will be position adjustment ahead of the weekend with choppy trading realistic.