FX outlook: Parky’s quick take – 7 September 2020

08 September 2020

Neil ParkerFX Markets Strategist

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What’s happening with currencies this week? Neil Parker, Market Strategist shares his views.

United Kingdom

Trade negotiations continuing, will they dampen Sterling?

The UK data and surveys suggested that July and August had seen a solid recovery in activity, albeit slightly less robust than initially estimated. In construction, the PMI (Purchasing Managers’ Index) slowed in August as the industry had fewer projects to catch up on than in previous months.

The UK & EU concluded further talks on trade with no breakthrough, and Michel Barnier, the EU’s Chief trade negotiator, was left exasperated by the UK’s refusal to compromise on key issues such as fishing rights.

All of this put pressure on the GBP last week, but perhaps the greatest pressure was brought to bear following comments from Bank of England officials. Deputy Governor Dave Ramsden made it clear that the Monetary Policy Committee had plenty of firepower left at its disposal via unconventional measures. He suggested that the BoE (Bank of England) could add significantly to the £745bn of asset purchases already sanctioned, and could accelerate the purchases if necessary. In written remarks, external member Gertjan Vlieghe warned that around 1.5% of economic output could be permanently lost, and the risks of the pandemic meant that persistent disinflationary forces could remain for years. Again, whilst the BoE have negative interest rates available in their monetary policy toolbox, it still looks as if they’ll favour additional asset purchases over them. GBP/USD slipped back from highs close to $1.35, and GBP/EUR reversed from a high of €1.1279, as markets digested this. Over the weekend, news stories emerged that the UK government are planning emergency legislation to override a key part of last year’s Withdrawal Agreement. That could also be a driver of GBP weakness, with the trade negotiations entering the final, critical, phase.

This week sees little due for release of any importance ahead of Friday’s plethora of releases, which centre around the July monthly GDP (Gross Domestic Product) figures. In all likelihood, the reopening of more of the UK economy in July, including much of the services sector is likely to see a further sharp improvement in GDP growth, but could it match, or even better, the June figures? That’s probably an outside risk, but another strong performance from the economy is necessary, given how sharp the drop in output was. The pull back in GBP/USD and GBP/EUR may be because the market is already short USDs, and an uncertain outlook regarding UK trade negotiations which formally continue this week is also holding back the pound. Strong current fundamentals are one thing regarding current levels, but greater optimism regarding future activity is a likely staple for future strength.  

Europe

EUR under pressure, as European Central Bank (ECB) decisions linger

In Euroland, ECB (European Central Bank) Chief Economist Philip Lane gave a speech on Tuesday and warned that the EUR/USD rate does matter in terms of inflation forecasts and monetary policy setting. That speech on Tuesday evening came after the August consumer price inflation figures recorded a return to deflation on the headline reading, and the lowest core inflation reading on record, something that will have likely reverberated around the ECB’s headquarters in Frankfurt.

The ECB has so far not really waded into the debate over monetary policy, whilst the US Federal Reserve and Bank of England have indicated that they see persistent downside risks to inflation and permanent damage to growth, which could require prolonged and possibly additional monetary accommodation. Nevertheless, they are likely to reduce their 2020 inflation forecasts, such that the CPI (Consumer Price Index) undershoots its target by even more.

That argues for further asset purchases, but the ECB is in a similar place to other major central banks in that they don’t feel the need to rush. Weak manufacturing and services PMI figures in the preliminary August readings were not significantly altered in last week’s final outturns, and whilst services activity did rise a bit on aggregate, that was entirely due to a German rebound, with other major countries all experiencing some reversal from July.  The EUR enjoyed a reversal of its own, reaching a brief peak above $1.20 on Tuesday before dropping back sharply, at one point to as low as $1.1781 on Friday.

The ECB Governing Council meeting may adjust some peripheral measures to make liquidity available to banks, but they are not expected to make any adjustments to the major policy measures this time. There is little data to offer much support or pressure to the EUR ahead of the ECB meeting, and it may be the press conference, following the monetary policy decision, that proves of greatest interest to markets. Will the President, Christine Lagarde, support her Chief Economist regarding concerns over the euro’s strength? Will the worries over deflation risks prompt some change of language in the statement? The risks to the euro are likely to be to the downside. Moreover, any hints from the ECB that there is more monetary loosening to come likely to add to the resistance for any renewed test of $1.20.

United States

Strong unemployment data, but recovery still shaky

Although the US non-farm payrolls data on Friday recorded another 1.37m jobs added to the payroll in August, this was the weakest gain since the US economy reopened after lockdown. There was a drop in the unemployment rate from 10.2% to 8.4%, and the underemployment rate dropped to 14.2% from 16.5%.

The other labour market data and surveys released ahead of the payrolls figures showed that there were 881k new jobless claims in the week ending 29th August, and over 13.2m continuing claims in the week ending 22nd August. The US labour market remains a long way from normal, or rather its pre-pandemic levels, and that is likely to continue to delay the economic recovery, even though on the face of it the US economy has been one of the stronger performers of the major economies in the first half of 2020.

The Federal Reserve’s Beige Book seemed, on the surface, to offer additional optimism, suggesting that most districts had recorded further modest improvements in activity. However, the Fed also highlighted fragility to the recovery, with signs that firms were planning to layoff furloughed staff, once support schemes came to an end, and heightened concerns over personal and business debt.

Despite the ongoing economic challenges, Senate Majority Leader, Mitch McConnell, indicated last week that the possibilities of any bipartisan fiscal stimulus deal being passed by the House of Representatives had receded, with talks between the Senate and House leaders bearing no fruit. With Republicans and Democrats looking towards the fast approaching Presidential elections, views on where additional stimulus should be targeted may become more polarised.

This week’s data and survey releases are relatively uninspiring, with only the consumer price inflation for August due on Friday likely to offer much additional insight. After the Euroland inflation figures last week showed a collapse in price inflation, what will the US figures show? The consensus expectations are for a rise in the headline rate to 1.2% from 1%, and the core rate to remain at 1.6%, but could there be some negative price shocks from industries still struggling because of the coronavirus? How will that affect risk appetite and the US asset markets? 

Moves back towards US Treasuries and away from equities have been USD supportive lately, and a surprise dip in CPI inflation would likely have that effect on asset markets. In absence of any constructive progress on a stimulus deal, there may be greater interest in the Fed’s decision next week (16th September). Could they lay the groundwork for additional loosening over the final two meetings of the year?   

Rest of the world

More monetary loosening? Not likely this week

The ECB meeting will clearly be the most important central bank meeting of this week, but isn’t likely to produce a material change to monetary policy. The same is true of the BoC (Bank of Canada) meeting, due on Wednesday, where the BoC is expected to leave policy unchanged despite very low inflation rates recorded in July and little sign of any improvement likely in August. Canadian employment figures recorded broadly in line employment growth, further reversing the job losses seen during the height of the COVID crisis, and offer a counterpoint to the lack of inflation.

Ahead of the Bank of Canada meeting we have the Kazakhstan central bank’s decision on interest rates on Monday. Interest rates fell from 9.5 to 9.0% at the July meeting. Since then, there has been some lockdown restriction easing, which makes an additional cut look unlikely at this meeting, even with the Kazakh President Tokayev applying pressure.

The National Bank of Malaysia announces its decision on Thursday, ahead of the ECB meeting, and again no change is expected after repeated cuts in previous meetings. That said, Q2 GDP data was a lot worse than expected, there is persistent deflation, and the manufacturing PMI slipped back below 50 in the August reading, so it shouldn’t be completely ruled out.

The Central Bank of Peru round the week out, with no change in monetary policy expected from them either. Some risks in terms of monetary policy, but overall this week may be more about laying the foundations for future monetary loosening.

To read the previous quick take, click here

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