Rates or Brexit?

Pound at a crossroads

The recent precipitous fall in the value of the pound appears to be over but the overall weakness continues. To be able to plot a path for Sterling over the next few months it is necessary to try to “rank” the drivers for not only their influence on the currency but the market’s perception of that influence.

It is obvious that traders, or at least hedge funds created large long positions in the expectation of a rate hike at the meeting of the Bank of England’s Monetary Policy Committee which takes place today. They carried the market with them until Governor Mark Carney poured cold water on the idea and the chances of a hike fell from 90% to around 10% in a very short time. Now that influence is over they will probably be a little chastened despite still expecting a rate hike in the coming months.

Brexit rumbles on as an influence on the currency and the closer we get to March 2019, the less opportunity the market will have to put it to the back of their minds and allow an optimistic view to grow.

We all have a view on the pros and cons of Brexit, but the economic reality is that for a nation to throw out one set of trading partners and try to build another is, in the modern world, going to create an economic slowdown, which may be temporary but will take years rather than months to bring benefit.

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MPC meeting downgraded from vital to interesting

Central bank meetings tend to hold the market in thrall as it is an opportunity to hear “from the horse’s mouth” just what the Bank’s vision of their economy is. That is of course if you believe the veracity of the comments.

Central Bank influence was downgraded following the financial crisis as they did all they could then sat back to watch the effect of extraordinary levels of accommodation.

Today’s MPC meeting had been expected to raise short term interest rates to combat inflation which remained stubbornly high. Putting aside the comments of the Governor which removed those expectations, the notion of a rate hike in such a fragile economy was, for me, a crazy notion.

The pound’s recent rally wasn’t a vote of confidence in the Bank of England more a reaction to the perception of higher rates which must be good for the currency.

The pound appeared to have made a short-term bottom yesterday and seemed to rise although the truth was that it opened and closed at the same level, 1.3546. It has risen a little overnight reaching a high (06.30 BST) of 1.3578.

The next move in the pound is likely to be a little higher as short positions are “cashed-in” but from there it becomes something of a lottery. I still believe that tighter monetary policy would be a mistake no matter what the inflation data is next week since Brexit remains and will continue to be by far the biggest influence on every aspect of the economy, and the prospects to not appear good.

Dollar rally unsustainable?

The recent rally in the dollar has had virtually nothing to do with the U.S. economy, reflecting the importance of the Greenback globally. It has been more to do with President Trump’s ability to “pull rabbits from hats”.

The Iranian treaty withdrawal may be a step too far and Trump’s motives could be based in his desire to reverse as much of his predecessor’s achievements as possible, although he would probably say he is merely fulfilling yet another campaign pledge.

It remains to be seen how this whole thing plays out since the U.S. has been placed in direct (figurative) conflict with three of its biggest allies.

So far, the FX market seems to be ambivalent towards Trump’s actions not sure yet how this affects the dollar. It is difficult to really judge as it is more how reaction is perceived globally. The fall in risk appetite precipitated by the announcement may have given the dollar a final push to in this round of strength.

The fall in the Euro through strong support at 1.1880 has not precipitated the collapse that may have been expected, so it is possible that dollar’s rally may be coming to an end. Yesterday the dollar index was virtually unchanged closing at 93.11, unable to seriously test the next resistance at 93.50. This coincided with the single currency making fresh lows of 1.1822 where it received “natural” buying interest.