Currency Market Analysis


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Jun 23, 2022 | Currency Market Analysis

Global Themes

Recession concerns pushing risk assets lower

• Markets are not buying the soft-landing narrative
• European politics is getting messy again
• UK inflation hits 40-year high as expected

Delivered by Boris Kovacevic

US dollar

Markets are not buying the soft-landing narrative

Estimating the probability of the next US recession has become a sport on Wall Street. Investors have recognised the difficult task ahead of the Federal Reserve and have positioned accordingly. The S&P500 is on track to record its worst first half of any year since the 1970s. The window for a soft landing is getting narrower.

Yesterdays speech of Jerome Powell before congress had something for everyone. The optimists pointed to Powell’s positive assessment of the general state of the economy, while the pessimists focused on the fact that, for the first time since the pandemic, the chairman acknowledged that recession might be a possibility. The updated New York Feds GDP Nowcast stands in stark contrast to Powell’s constructive view and puts the probability of negative growth in the fourth quarter and first half of 2023 at 80%.

  • This re-pricing of recession risks has mainly resulted in a fall of the terminal Fed funds rate (expected rate at the end of the hiking cycle). This dynamic explains not only the paradoxical outperformance of US stocks against its European peers this week, but also the bid for bonds and the recent.

Euro

European politics is getting messy again

Investors have started buying the Euro again, dragging EUR/USD higher on six out of the last seven trading days. The risks surrounding the Eurozone and the common currency, however, remain heavily tilted to the downside. This week’s developments – especially on the political stage - have made this very clear.

Consumer confidence tracked by the European commission has deteriorated quicker than expected and is currently just short of the all-time low set in April 2020. Voters have started expressing their disappointment in elections. The party of French president Emmanuel Macron has not been able to secure an outright majority in the latest parliamentary elections, making Macron dependent on other parties. Italy is facing its own governmentcrisis in the meantime. Foreign Minister Luigi Di Malo has quit the Give Star Movement and has announced plans to start his own party. This could change the power dynamic within the government and gives more power to Matteo Salvini’s League.

  • Investors and the Euro have so far shrugged off political risks which have been overshadowed by developments on the monetary and macroeconomic front. But nonfunctioning coalitions in France and Italy and the risks of Germany being cut off from the Russian gas supply could weight on the Euros medium term prospects.

British pound

UK inflation hits 40-year high as expected

Britain’s inflation is currently at the highest level since 1982. The yearly rate of 9.1% hit in May will very likely not be the high of this cycle. The Bank of England is expecting consumer price growth to reach double digits later this year, peaking at around 11%. The UK now has the highest inflation in the G7 group.

Average pay is currently not keeping up with rising prices and has led real wage growth to turn negative earlier this year. This has led the UK consumer confidence index published by the GFK institute to new all-time lows, eclipsing episodes during the pandemic and global financial crisis in 2008. Britain remains highly exposed to the stagflationary environment of higher prices and weaker growth, as pointed out by the World Bank two weeks ago.

  • GBP/EUR has been creeping lower and is on track to close weaker for the second week in a row. The pair is currently trading within a range between 1.1470 and 1.1740/70 but missing conviction has limited this weeks moves.

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