Liquidity keeping Sterling afloat

The pound continues to be dragged in several directions by the continuous flow of rumour regarding the chances of the UK leaving the EU at the end of next month with a deal in place.

This week, the High Court will issue its verdict on whether Boris Johnson’s suspension of Parliament was legal. If the Court finds in favour of those disputing the suspension, it is unclear what will happen next. Parliament could be recalled with the Labour Party Conference having just started and the Conservative Party convening this weekend. It may also be that this is little more than an expensive and wholly unnecessary distraction.

As the clock winds down on Brexit, the pound is becoming more sensitive to every twist and turn in the negotiations. Over the past three years, we have seen liquidity in the market become stretched on several occasions and two or three times this has led to a flash crash. The market seems more “balanced” now and although the majority are still short of Sterling, the position sizes have shrunk, and traders have become warier of holding on to a position indefinitely.

In the coming weeks as the EU Summit approaches, Brexit will become a binary issue. The UK will either be leaving the EU on October 31st or it won’t (according to Johnson it will). If it is leaving on that date, then it is a case of whether it is with a deal or without a deal. The pound is likely to become more volatile as short positions are either trimmed (or liquidated completely) or added to. Volatility is likely to increase exponentially as the Summit approaches.

Last week, the pound remained driven almost entirely by Brexit with the Bank of England meeting barely warranting a second glance from the market. This week is likely to be similar, particularly since there is no data to be released that will distract traders from the “main event”.

Last week the pound traded in a 1.2507/1.2392 range versus the dollar, closing just nine pips lower on the week at 1.2470.

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Rate speculation to be the main driver for the dollar

Following the most recent FOMC meeting Jerome Powell, the Chairman of the Federal reserve maintained his stance of allowing the market to interpret his remarks without giving firm guidance as to the Central banks’ thoughts on how the U.S. economy is truly faring.

Traditionally, Central Banks in most developed economies look to work “hand in hand” with the markets by giving sufficient guidance for traders to “do their bidding”.

For example, if they wish to see a weaker currency they may “verbally intervene” by providing either a downbeat outlook for the economy or a hint that rates will either be cut or that a cycle of cuts is about to start. It can be more difficult to influence positivity as the ECB is finding currently.

On balance, the market believes that the latest cut in rates may be the last of this year as the Fed takes Q4 to judge the effect of the fifty basis points of rate reductions it has put in place at its past two meetings.
Powell’s comments that the cuts have been “mid-cycle adjustments” are typically ambiguous and traders have interpreted them as a sign that their effect will be measured before any further “adjustment” is made.

Last week the dollar index continued to drift as the market was unable to make a clear decision on the Fed’s intentions. It traded between 98.75 and 98.04, closing at 98.46.

Personal Consumption data which is the Fed’s preferred measure of inflation will be released this week. While inflation has been controlled throughout the year, there have been signs recently that it is starting to pick up. This is clearly one of the factors that will influence the Central Bank going forward so traders will be more interested than they have been recently when the data is released on Thursday.

The final cut of Q2 GDP will also be released and there is a view in the market that growth may be adjusted lower to 2.4% from 2.5%, although this is unlikely to have a significant effect.

Activity and confidence data to disappoint

While there has been an almost discernible feeling amongst traders that the Eurozone economy is reaching its nadir, its patience is starting to wear thin. Another month of weak and weakening activity numbers may be the catalyst that sees the pivotal 1.1000 level for the single currency against the dollar finally conclusively broken.

Later this morning manufacturing and services data will be released for France, Germany and the Eurozone as a whole.

The French and German economies have been in recession in all but name for most of the third quarter while the region has teetered on the brink. Following the gallant but vain attempt of the ECB to inject some life into the economy, today’s data is unlikely to show any marked improvement.

In France, manufacturing will remain just about above the line between expansion and contraction while in Germany that distinction was broken a long time ago. Manufacturing activity will remain in a severe downturn, although it is likely to have improved marginally slightly from 43.5 last month to 44.

The overall Eurozone figure may also have improved slightly but will remain in contraction and 47.3.

The euro continues to threaten to collapse but remains anchored by its contribution to the dollar index. Last week it traded between 1.0990 and 1.1087, closing at 1.1017.