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Currency Market Analysis

Aug 21, 2019 | Currency Market Analysis

Global Themes

All eyes on Boris in Berlin
- Sterling seesaws on Brexit updates
- Sterling versus other currencies
- Beware Fed minutes tonight
- Mr Conte resigns as Italy’s PM


Sterling seesaws on Brexit updates
It was another choppy day in the currency market yesterday, as Sterling staged a hasty relief rally after traders reacted to comments made by German Chancellor Angela Merkel regarding practical solutions to the Irish backstop mechanism. GBP/USD vaulted over 1-cent from its daily low to $1.2181 and GBP/EUR leapt towards €1.10.

Yesterday’s trading activity was a fine example of just how sensitive Sterling is to unpredictable Brexit-related news. Sterling is trading ever more like an emerging market currency for this reason, at risk of sharp and erratic moves, near impossible to forecast. Sterling was actually weakening prior to Ms Merkel’s comments because the European Council President Donald Tusk shunned UK Prime Minister Boris Johnson’s letter requesting the removal of the Irish backstop. However, the softer tone by Ms Merkel was cheered by traders betting positively on the pound, as demand soared albeit for only a few minutes, before momentum slowed. The recovery rebound shouldn’t come as a huge surprise given the extent traders have heavily shorted Sterling - betting on it depreciating further – over the last few months, giving room for a rally as traders offload some of these positions and take profit.

The pound has lost nearly 10% of its value since mid-March, but as critical levels to the downside are approaching, traders appear less inclined to build on their short positions for now. Mr Johnson is due to meet with Ms Merkel in Berlin today to continue to discussing the Irish backstop. Sterling’s direction will likely be dictated by any optimistic or pessimistic views disclosed. 

Sterling versus other currencies
Despite the dramatic devaluation of the pound since the UK voted to leave the EU in 2016, the last seven days depicts a welcomed rebound to the upside against multiple currency peers.

The biggest movers have been GBP/JPY, GBP/NOK, GBP/PLN and GBP/SEK all appreciating over 2%, closely followed by GBP/CHF, GBP/NZD and GBP/EUR. Over the last four weeks, GBP/ZAR has jumped a massive 7.3% and is one of only a few GBP currency pairs to be higher over a 12-month period.

As reported above, the bounce higher in Sterling is no huge surprise given the extent of its decline of recent months, but it doesn’t mean to say the downtrend is over. With the Brexit deadline of October 31 fast approaching and Mr Johnson reiterating his desire to leave the EU with or without a deal, the risk of Sterling falling to new post-referendum lows on a no-deal Brexit poses a major headache for Sterling traders and businesses involved in international trade.


Beware Fed minutes tonight
The US Federal Reserve’s (Fed) minutes of its July meeting will be released at 7:00pm this evening and could spark some volatility in financial markets. The US Dollar index, which measures the dollar’s value versus a basket of currencies, snapped a 5-day winning streak yesterday.

The dollar has come under selling pressure over recent weeks as investors weigh up the potential for further rate cuts by the Fed before year-end. Yesterday, Fed member Mary Daly agreed with the need to cut interest rates to counter economic headwinds and keep the US economy in expansion. The dovish rhetoric comes amid the rise in geopolitical tensions, slowing economic growth and recession fears, which has tainted market sentiment and helped fuel demand for the so-called safe-haven assets, which include the Japanese, Swiss and US currencies. The safe-haven demand for the dollar has therefore limited USD downside. In fact, EUR/USD, the most traded currency pair in the world, slumped towards $1.10 again yesterday, before reversing course towards $1.11. The seemingly fatigued Euro brushed off the resignation of Italy’s prime minister and attempted to build on its recovery run, but ongoing worries around the health of Germany’s economy is likely to cap any meaningful gains.

Any changes to the Fed’s rate expectations, as a result of the minutes tonight, could affect EUR/USD, with a not so dovish surprise potentially dragging the pair under $1.10, a move not seen since May 2017.


Mr Conte resigns as Italy’s PM
Giuseppe Conte resigned as Italy’s Prime Minister yesterday, after accusing Matteo Salvini, the leader of the anti-immigration League party, of deepening the country’s political crisis by calling for an election and hindering budget negotiations with Brussels. The Euro largely ignored the political turmoil, but more uncertainty remains on the horizon.

Italian President Sergio Mattarella begins formal consultations today to establish whether a new coalition government can be formed or else face a general election, possibly in October. The general expectation is to see the League party remain in government and therefore not disrupt the political procedure in Italy too much to spark Euro volatility. However, focus on Italy’s budget proposal to the EU will be key as investors weigh up the potential for further altercations between Rome and Brussels, which could add to the common currency’s downside bias.

GBP/EUR has climbed over 2% since the start of last week, helped by Sterling’s rebound but also by Euro weakness. Despite the uplift, the currency pair is still at risk of testing the 2-year lows near €1.07 again if Brexit pessimism comes back to haunt the pound.

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