Post date: 04/11/2019 16:02

The Federal Reserve’s ‘hawkish cut’ last week did little to help the US dollar. Economic data worldwide is showing a modestly better tone, especially relative to the depressed expectations of a few weeks ago. For now, the net effect in currency markets has been to reverse safe-haven flows into the dollar, sending the greenback lower against every G10 currency, save the Canadian dollar. Emerging markets also had another strong week, with the exception of the Chilean peso and the South African rand, beset by domestic problems. Now that major central bank meetings are either out of the way or unlikely to bring important changes in the near future, the focus is back on economic data to guide FX markets. In addition to the Bank of England meeting on Thursday, we will be paying close attention to industrial and factory orders data out of the Eurozone throughout the week.


The Pound continues to benefit from the removal of the no-deal Brexit tail risks, which the market now prices in at less than 10%. Last week’s rally did, however, have more to do with general dollar weakness than pound strength. In line with our long-held expectations, UK politicians have accepted that a general election is a precondition for any Brexit solution, and one is now set for 12th December. Given the large lead for the Conservatives in the polls, our base case is for a comfortable Tory majority that allows an orderly Brexit in the terms of the second Withdrawal Agreement that narrowly rejected by Parliament last month. In this scenario, there is room for further sterling gains, although we note that Labour outperformed the polls in the last election and a hung parliament cannot be ruled out.


We are seeing two parallel developments that could be positive for the common currency. First, hard data (GDP growth and core inflation, most recently) is outperforming the low expectations set by more subjective survey data (such as the PMIs). Second, the chorus of policymakers asking for fiscal stimulus as a complement to ECB monetary stimulus is growing louder. The new ECB President Lagarde has made it clear she is completely in tune with the outgoing Draghi on this front. The weak numbers out of the German manufacturing sector and the populist surge in some German state elections mean that at the margin such stimulus is becoming more likely. We think that any significant news on this front would be a catalyst for a euro rally.


The Federal Reserve cut rates last week, as expected, but contrary to market expectations it made it clear that it will be on hold unless and until the US economy weakens materially from its current cruising speed. It did throw a bone to the doves, by suggesting that the threshold for hiking rates is even higher, and it will need to see clear evidence of significant inflation pressures before it considers such a move. Markets, however, ignored this ‘hawkish cut’ and focused instead on the marginal easing of US-China tensions, the generally better tone of economic news worldwide, and the removal of the prospects for a no-deal Brexit to send risk assets higher and the dollar lower for the week. Even a moderately better-than-expected nonfarm payrolls number out on Friday couldn’t help the greenback.