Currency Market Analysis
Aug 26, 2021 | Currency Market Analysis
After dropping 33% in March 2020, the MSCI world equity index has rallied about 95% and the British pound was strongly positively correlated up until about June this year. GBP/USD appears to have decoupled slightly given its depreciation of late whilst stocks hit all-time highs. But if the stock rally does fizzle, how might the pound react?
Over the coming months, there is a growing risk of heightened volatility from current low levels of volatility, with rising fears about the Delta variant and the cutting back of central bank stimulus threatening the global economic recovery. A correction in global equity markets is arguably long overdue but the timing of that correction is anyone’s guess. The fundamental landscape is still supportive given the cheap credit and excess liquidity driving demand for risk-prone assets. Stimulus won’t last forever though and when we do see the US Federal Reserve (Fed) scale back, investors are likely to take profit on risky bets, which might not bode well for the risk-correlated pound, especially against the safe haven US dollar. So if stocks do correct lower before year-end, the pound could follow suit.
- In the short-term, the pound has extended its rebound from 1-month lows and could test the $1.38 level against the US dollar. Resistance around this level will be strong though given the downward sloping trend line developed in August and the converging 50-and 200-day moving averages.
Supply chain woes escalate
Alike inflation, supply chain disruptions were largely thought of as temporary. However, in a world cautiously navigating the ongoing pandemic, the closure of factories, self-isolating rules, travel restrictions and pent-up demand all continue to contribute to persistent supply chain issues that are showing no sign of abating any time soon.
Raw material and component shortages as well as higher commodity and energy costs are increasing the competitive conditions companies face when trying to ship their goods. This is one reason why freight rates have soared to record highs with the cost of sending a container from Asia to Europe about 10 times higher than it was in May 2020. The spread of the Delta variant, especially in Southeast Asia, is choking factory production and disrupting shipping, whilst in the UK, businesses are dealing with record low levels of stock at the same time as retail prices rising at the fastest pace since November 2017. The UK’s exit from the EU also continues to upset supply chains, with a rising shortage of a range of food products being the latest warning.
- New trade barriers and ongoing geopolitical uncertainties with the EU means the UK’s reliance on trade with Asia, specifically China, has increased. But supply chain constraints are expected to extend well into 2022, especially given Asia’s slower vaccination campaign.
The key risk event of the week is Friday’s speech by Fed chair Jerome Powell. Risk appetite has improved globally since concerns about the Fed tapering too soon have moderated. Still, all eyes are on Powell and any fresh guidance on tightening monetary policy. The US dollar has weakened along with safe haven counterparts JPY and CHF this week, whilst risk-correlated currencies like ZAR, NOK, CAD and the Antipodeans have firmed.
Although the spread of the Delta variant is slowing the global economic recovery, it is not expected to derail it, but the early removal of central bank stimulus and a rise in borrowing costs over the long term could inject more uncertainty into markets, which have performed well over the past week thanks partly to the FDA’s full approval of Pfizer’s Covid-19 vaccine. The market reaction to a hawkish Fed at Jackson Hole tomorrow would likely boost dollar demand, but even a dovish Fed could tigger safe haven buying and strengthen the world’s reserve currency.
- EUR/USD has risen for four days straight but is bumping into resistance just beneath the $1.18 threshold. Should the dollar enjoy a strong end to the quarter, EUR/USD could slide towards the $1.15-$1.16 zone. Such a move could allow GBP/EUR to climb whilst GBP/USD falls, although safe haven flows may limit GBP upside.
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