Dampening Equity Sentiment Could Test GBP Resilience

SAXO

Economic

Central Bank

Forex

Summary:

GBP has been the best performing G10 currency so far in this quarter, but the resilience of sterling will be tested with much of the good news now priced in and wage pressures starting to top out…

Sterling has been the best performing G10 currency so far in Q1, as the outlook for the UK economy has shifted in a big way compared to 2023. Last year, UK economy faced a constant stagflation threat due to high services inflation and wage pressures but deteriorating economic activity. However, the economy is looking at a better 2024 which has given room to the Bank of England to delay its rate cut cycle. Markets expect BOE to cut rates in August, compared to Fed and ECB that are expected to start cutting rates in June.

On Friday, GBP/USD rose to fresh YTD highs of close to 1.29. A neutral UK budget and weaker US dollar has also been pushing sterling higher, but the rally is likely to be tested in the coming days and weeks. EUR/GBP tested the 0.85 support again on Friday before bouncing higher. We see the following as key tests in the weeks ahead for the GBP resilience to be maintained.

Bearish equity sentiment

As we have noted previously, GBP/USD is a compelling risk sentiment play. Our regression analysis between different FX pairs and MSCI All-Country World Index (MSCI ACWI) on a quarterly basis over the last two decades showed a high correlation for GBP/USD to the global stocks index.

Equity sentiment is starting to falter after strong gains in Magnificent 7 stocks since the start of the year. The big single stock story on Friday was the huge intraday move in Nvidia – the market darling – with the stock moving 11% from the high to the low. This is a very bad signal in terms of market health, given that Nvidia is a $2 trillion company. Key focus this week is whether the market will reverse, and volatility will pick up. If that was to happen, it could mean some safe-haven flows back to the dollar and other safe-havens such as JPY and CHF, and a hit to the risk sensitive currencies such as GBP.

The US CPI release today is also making markets jittery. Any risk of a hot February inflation will seriously question the disinflation trends, and potentially shift the Fed expectations in a hawkish manner. Dampening Equity Sentiment Could Test GBP Resilience_1

Dampening Equity Sentiment Could Test GBP Resilience_1

BOE comments and UK wages

BoE policymaker Catherine Mann said on Monday that the UK has a long way to go for inflation pressures to be consistent with the central bank's 2% target. However this did not bring around strong gains in sterling on Monday as the expectation around delay in rate cuts is well priced in by markets. In fact, sterling was the worst performer in G10 FX space on Monday, possibly underpinned by a bearish equity sentiment.

Last month, BOE Governor Bailey said there had been “encouraging signs” on the key indicators in the jobs market and services prices, even as he stressed that policymakers are looking for evidence that progress can be sustained.

And the data out today on UK labor market data for the three months ending January showed that labor market is cooling, even as it remains tight by historical standards. Wage growth, excluding bonuses, came in softer than expected at 6.1% YoY (vs. 6.2% exp) in the three months to January. In the same period, Average Earnings growth, including bonuses, eased to 5.6% from the prior reading of 5.8% and expected growth of 5.7%.

The BOE noted at the last meeting that risks from domestic prices and wages were more evenly balanced. Its forecast is for inflation to fall temporarily to 2% in Q2 2024, before picking up in Q3 and Q4, and settling around 2.75% by the end of the year. These wage numbers could easily be a factor underpinning a dovish shift in BOE votes, where two of the members have been voting for a rate hike still at the last meeting. Economic growth concerns will also underpin, especially after the budget boost has remained minimal. UK unemployment rate increased to 3.9% in the three months to January, and consumer confidence slipped back in February, suggesting households are not ready to splash out. Next BOE meeting is on March 21, and February CPI will be released on March 20. Traders could wait for US CPI event risks before more seriously considering a bearish posturing for sterling.

Positioning and technical indicators

The recent COT report for the week ended 5 March 2024 showed that speculators opened 10,300 buy contracts and closed 1,700 short positions in GBP. As a result, the net position of non-commercial traders increased by 12,000 contracts in a week. The long position in GBP is now at its highest since August 2023. Dampening Equity Sentiment Could Test GBP Resilience_2

Dampening Equity Sentiment Could Test GBP Resilience_2

Technical indicators are also signaling that sterling may be getting close to overbought territory. We use RSI and Bollinger Bands to show short-term overbought conditions in the charts below, which could signal near-term, pullback in case of a data miss, especially given the lack of follow-through on Friday’s break to fresh YTD highs.

The first key support for GBP/USD is at the 1.28 handle, following which strong support is seen at 21DMA at 1.2680. GBP has gained the most against the JPY and CHF year-to-date, followed by AUD. If BOJ pivot expectations continue to grow, GBP/JPY could test 100DMA around 186. Likewise, GBP/AUD risks slippage towards 100DMA around 1.9150. Dampening Equity Sentiment Could Test GBP Resilience_3

Dampening Equity Sentiment Could Test GBP Resilience_3

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Risk Warnings and Disclaimers

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Zi Cheng

Economic

Stocks

Stocks in Asia fell Wednesday after solid economic readings and higher commodities prices spurred speculation that major central banks will keep interest rates higher for longer.

Benchmarks in South Korea and Hong Kong led the region’s decline. Mainland Chinese shares were little changed after a report showed expansion in the Caixin purchasing managers’ indexes. Contracts on US equities edged lower after the S&P 500 fell 0.7% in Tuesday trading.

Taiwanese equities weakened on news that the region had been hit by the strongest earthquake in 25 years. Shares in Taiwan Semiconductor Manufacturing Co. were lower as the company evacuated factory areas following the shock, endangering production at the world’s largest maker of advanced chips.

Pressure on US equities followed better-than-estimated data on US job openings and factory goods orders that added to skepticism about the pace of Federal Reserve easing. Traders now project fewer rate cuts in 2024 than the central bank itself.

“Stock bulls may find it difficult justifying buying stocks at these elevated levels as yields rise,” said Fawad Razaqzada at City Index and Forex.com. “Rising cSourrude oil prices pose additional risk to the inflation outlook. Additionally, numerous jobs reports are expected throughout the week. Trading could be volatile.”

Source: Bloomberg

Treasuries were little changed during Asian hours after further selling pushed yields higher on Tuesday, when the 10-year yield touched the highest level since November. The moves were reflected in Australian and New Zealand yields, which climbed Wednesday.

An index of the dollar was little changed. The yen was also flat against the greenback at around 151 per dollar, remaining around the weakest level of the year — keeping alive the possibility of official intervention to the support the currency.

Tatsuo Yamasaki, Japan’s former vice finance minister for international affairs, said the government “can step in as soon as the yen falls beyond the current range,” in an interview Tuesday.

The yuan, meanwhile, traded close to the weak end of its onshore trading band, the latest sign that a recent slew of upbeat economic data hasn’t been enough to bolster the Chinese currency.

In commodities, oil steadied following a rally Tuesday after an industry report pointed to a drawdown in US crude inventories, ahead of an OPEC+ meeting at which the group is expected to affirm current supply cuts. Gold was steady to hold a rally over the past six sessions, while Bitcoin was little changed at around $65,500.

No Rush

As traders awaited remarks from Fed Chair Jerome Powell on Wednesday, they weighed comments from two officials who vote on monetary policy decisions this year. San Francisco Fed President Mary Daly and her Cleveland counterpart Loretta Mester said they still expect the central bank to cut rates three times in 2024 — though they’re in no rush to begin lowering borrowing costs.

Swap traders are currently projecting about 65 basis points of rate reductions this year — less than the 75 basis points signaled in the Fed’s latest “dot plot” forecasts.

“Our base case is that the Fed engineers a soft landing and starts to cut rates in the second half of the year,” said Gargi Chaudhuri at BlackRock. “The downside risks to economic growth have diminished, so the risk of only two Fed rate cuts now appears higher than the risk of four cuts.”

In other corporate news, Tesla Inc. delivered just 386,810 vehicles in the first three months of the year, missing Bloomberg’s average estimate by the biggest margin ever in data going back seven years. The carmaker’s shares fell 4.9% Tuesday in New York.

Source: Bloomberg

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Zi Cheng

Economic

Stocks

Perpetual Investment Management Ltd. stock picker Anthony Aboud is putting on an early wager on the benefits of artificial intelligence for Australia’s banks.

Commonwealth Bank of Australia stands to gain the most among peers, given its track record as an early adopter of technological innovation, he said in an interview in Sydney. AI will help the country’s largest lender cut costs as processes become more automated, he said.

Aboud’s comments reflect how investors everywhere are looking for ways to capitalize on AI, even in markets like Australia, which is dominated by global miners and banks. The savings for CBA may be significant, given how it spent more than A$7 billion ($4.6 billion) on the nation’s biggest banking workforce last fiscal year, according to data compiled by Bloomberg.

“If you were to believe that there would be cost out efficiencies through AI initiatives, CBA has historically been the one bank which could be able to capitalize on that first,” he said. In its February earnings statement, the bank said it’s increasing the use of AI tools for its mobile app and in efforts to train staff and hire engineers.

Source: Bloomberg

Banks “could benefit in the next three to five years from artificial intelligence” and should hold up as the Reserve Bank of Australia starts to trim rates from 12-year highs, he said.

His A$2.6 billion Perpetual Industrial Share Fund holds all of the nation’s big-four banks, though it’s underweight on the sector relative to its benchmark, the S&P/ASX 300 Industrials Accumulation Index.

Financials make up a third of the fund, which is up 13% this year, beating 88% of peers, according to data compiled by Bloomberg.

In the near term, Aboud also sees strength among the country’s lenders in the face of monetary policy easing, with traders betting the RBA will start lowering rates in September. The central bank signaled a further shift toward a neutral stance as minutes of its March meeting showed the board didn’t consider the case to raise interest rates for the first time since May 2022.

“Margins will probably stay stable” as rates decline, he said. “The probability of bad debts increasing with lower interest rates is probably lower, so they’ll probably do OK in that environment.”

Local bank chiefs have recently warned of slowing credit growth and cautioned over future profits. CBA’s half-year earnings in February showed margins under pressure from the fiercely contested market for home loans.

The lender’s shares are up 7.4% this year, trailing peers National Australia Bank Ltd., Westpac Banking Corp. and ANZ Group Holdings Ltd.

Source: Bloomberg

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Cohen

Economic

The tariff plan that Donald Trump has vowed to impose would likely send inflation above the Federal Reserve’s target and pressure the central bank to raise interest rates, Bloomberg Economics said in a report.

The presumptive Republican nominee is promising to slap 60% tariffs on imports from China and 10% duties on those from the rest of the world as he campaigns for a second term.

While there are many questions around the pledge — such as whether Trump would really turn it into reality — Bloomberg Economics plugged those numbers from his plan into a model for the US economy to estimate the impact. It found that following through on the campaign rhetoric would hurt US growth and raise the cost of living for Americans.

The Bloomberg Economics model shows the proposal sending the core personal consumption expenditures price index, the Fed’s preferred gauge of prices, up to 3.7% by the end of next year, well above policymakers’ 2% target. Economists surveyed by Bloomberg, on average, expect 2.1% inflation in 2025.

Trump’s plans would leave consumer prices 2.5% higher and gross domestic product 0.5% lower after two years, according to the model. That could pressure the Fed to choose between raising interest rates to curb inflation or cutting them to bolster economic growth.

Uncertainty around the projections is elevated. “There’s lots of variables in play and no recent precedent for tariffs at that level, so forecasting the impact is tough to do,” said Tom Orlik, chief economist and one of the report’s authors. “Still, we’d expect outsize tariffs to have an outsize impact, and our results underscore that risk.”

Trump fought a trade war with Beijing in his first term, though the US International Trade Commission, an independent US government agency, in a study released last year found a limited inflation impact from tariffs that he imposed on Chinese goods.

Duties levied on more than $300 billion in imports using section 301 of the Trade Act of 1974 only increased prices of US products by 0.2%, the commission found. The PCE index during Trump’s administration averaged just 1.6%.

But this year’s campaign promise from the former president who dubbed himself “tariff man” is far more sweeping than even the tariffs of up to 25% that he previously imposed on Chinese goods.

Source：Bloomberg

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Devin

Economic

A jump in domestic orders helped pull UK factories out of almost two years of contraction last month, according to a leading business survey.

Output from the manufacturing sector improved to a 20-month high in March, marking the end of a period of shrinking activity that started in July 2022.

Giving further evidence that Britain is beginning to recover from last year’s downturn, which drove the economy as a whole into recession in the second half of 2023, the S&P purchasing managers index (PMI) hit 50.3 – a figure above 50 indicates expansion.

The index monitoring new orders rose to 50.2 in March, up from 45.4 in February. Rob Wood, the chief UK economist at Pantheon Macroeconomics, welcomed the data, saying: "The long downturn in manufacturing output is over according to the PMI."

Factory owners had a difficult 2022 and 2023 and while domestic demand for manufactured goods has picked up, businesses continue to experience global difficulties that have restricted foreign orders.

However, S&P said hold-ups in the main shipping lanes through the Middle East amid attacks by Yemeni Houthi rebels on international shipping in the Red Sea were a cause for concern.

"March data signalled that the mild uptick in new business inflows was centred on the domestic market," it said. "The trend in new export orders remained weak in comparison, with overseas demand falling for the 26th successive month – albeit at the slowest pace since April 2023. Companies reported reduced demand from mainland Europe, with specific reference to France, the Netherlands, Belgium and Poland."

Manufacturers continued to shed jobs in March, but at the slowest since last May, with the employment balance rebounding to 48.0 from 43.3 in February.

Imports of raw materials and parts needed to complete the manufacturing process also contracted for a 21st month in a row, but at a slower pace.

Rolls-Royce was among a string of companies to show a strong rebound in orders and sales earlier this year, improving profits. Car companies have also staged a recovery after a long period of declining sales.

Wood said: "This isn’t just a flash in the pan, with the forward-looking indications from the PMI suggesting growth will improve further."

Expectations for growth in output over the next 12 months improved to 75.9 in March from 73.5 in February, above their average level of 72.4 since manufacturers were first asked about this in 2012 and the highest since April last year.

Export orders continued to fall, but the rate of decline eased. S&P said the index tracking new export orders improved to 47.8 in March from 44.2 in February.

James Brougham, the senior economist at the manufacturers’ lobby group Make UK, said the figures showed "manufacturing can return to a growth footing despite a challenging business environment".

He said firms were battling the effects on trade from Red Sea disruptions and the extra costs of high interest rates.

"Nevertheless, manufacturers are now hardened to the disruptive business environment they have had to endure over the past four years," Brougham said. "Despite the ongoing domestic political uncertainty, which is putting the brakes on investment decisions, this resilience means they are well placed to make the most of improving conditions in the year ahead."

Source: The Guardian

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Kevin Du

Commodity

Focus was now largely on a meeting of the Organization of Petroleum Exporting Countries and allies (OPEC+) due later in the day, although the producer group is widely expected to keep production unchanged.

Fears of a broader conflict in the Middle East- after Iran vowed retaliation against Israel for strikes on the Iranian embassy compound in Damascus- presented the possibility of more supply disruptions in the Middle East, helping oil surge to levels last seen in late-October.

Brent oil futures expiring in June rose 0.2% to $89.13 a barrel, while West Texas Intermediate crude futures rose 0.2% to $84.42 a barrel by 20:19 ET (00:19 GMT).

Expectations of tighter supplies helped oil prices rise past a stronger dollar and growing uncertainty over the path of U.S. interest rates. But these factors also limited broader gains in crude.

Oil prices had risen earlier this week after Mexico said it will also cut its oil exports.

US oil inventories seen shrinking- API

Data from the American Petroleum Institute showed on Tuesday that U.S. crude inventories shrank nearly 2.3 million barrels in the week to March 28- more than expectations for a draw of 2 million barrels.

While the reading comes after an outsized, 9.3 million barrel build in the prior week, it is also the third weekly draw in inventories over the past four weeks.

These draws pushed up expectations that U.S. oil markets were tightening, especially amid increased exports to fill the supply gap left by Russia and the OPEC.

Demand in the world’s largest fuel consumer was also seen picking up with the spring and summer seasons. The API data heralds a similar trend in official inventory data due later on Wednesday.

OPEC set to keep production unchanged

The OPEC+ is widely expected to keep production unchanged during a ministerial panel meeting later on Wednesday.

The cartel had recently said it will maintain its current pace of production cuts until at least end-June, singaling that markets had sufficiently tightened through late-2023 and early 2024.

Russia refinery disruptions, Middle East conflict buoy crude

Ukraine attacked Russia’s third-largest oil refinery earlier this week, although Reuters reports said the attack did not cause critical damage.

But the strike comes in the wake of several such attacks against Russia’s energy infrastructure- a trend that could potentially further stymie oil exports from Moscow.

In the Middle East, the prospect of Iran directly joining the Israel-Hamas war also rattled markets, after Tehran vowed retaliation for a strike against its embassy in Damascus, for which it blamed Israel.

Source: Investing.com

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Thomas

Economic

Bond

Bond traders are piling into bearish bets, fueling a selloff in benchmark Treasury securities, as fresh evidence of robust US growth triggers a recalibration of expectations for Federal Reserve interest-rate policy.

JPMorgan Chase & Co.’s latest client survey showed that outright short positions in US Treasuries rose to the most since the start of the year in the week leading up to April 1. That bearish sentiment spilled over into this week, helping to drive US 10-year yields to as high as 4.4% on Tuesday, a level not seen since November.

Reports released in recent days showed strength in manufacturing and jobs, underpinning a narrative of US resilience that has been gaining momentum all year. The latest data, combined with signs of sticky inflation and gains in commodities such as oil, has caused investors to further scale back predictions for the timing and extent of central bank monetary easing and gird for a period of higher-for-longer rates.

The Treasury market backdrop “is being shaped by rising growth expectations,” said Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investment.

Bond Traders Load Up on Bearish Wagers as Rate-Cut Odds Dwindle_1

It’s a similar story in the Treasury futures market. As bonds slid on Monday, traders amassed new positions across most of the futures strip, indicating a proliferation of short bets, according to data from CME Group Inc. Meanwhile, in the options market, the cost of hedging to protect against a selloff in longer-term Treasuries has climbed to the highest since the end of February, data show.

When it comes to Fed rate expectations, investors are now pricing in about 65 basis points of rate reductions in 2024, compared to the 75 basis points signaled by the median estimate of projections released after the Fed’s March meeting. That’s a switch from recent months, when traders’ forecasts were more dovish than the central bank’s.

With the market leaning so bearish, some traders are starting to take the other side of the bet. Tuesday’s activity in both Treasury options and those linked to the Secured Overnight Financing rate — which closely tracks the central bank’s key policy rate — included some large bullish wagers. The trades look to target a rally in the so-called belly of the curve — around the five-year maturity area — as well as half a percentage point of Fed rate cuts by the central bank’s September policy meeting.

Here’s a rundown of the latest positioning indicators across the rates market:

Treasury Clients Short

JPMorgan client short positions rose 7 percentage points in the week leading up to April 1 to the most since Jan. 1 on an outright basis. With long positions dropping 3 percentage points on the week, the net positioning shifted to the least long since Feb. 20.

Bond Traders Load Up on Bearish Wagers as Rate-Cut Odds Dwindle_2

Hedging Bond Selloff Gets More Expensive

The premium paid to hedge a selloff in Treasuries is on the rise. The cost to protect against yields rising on the long end of the curve reached the most expensive since the end of February during Tuesday’s session, as reflected by the so-called put/call skew on long-bond futures. In the Treasury options market, short volatility plays remained popular last week in both five- and 10-year tenors. Tuesday’s action has seen a couple of large bullish trades in the five-year tenor.

Bond Traders Load Up on Bearish Wagers as Rate-Cut Odds Dwindle_3

De-Leveraging Resumes

The latest CFTC data covering the week leading up to March 26 shows deleveraging continuing among asset managers and hedge funds. Leveraged net short positions in Treasury futures declined for an eighth straight week to the least amount since July. Beyond the macro rate narrative, the deleveraging may also reflect the continued unwinding of basis trade amid a less attractive backdrop for the strategy. Net long positions by asset managers also unwound for a third week in a row.

Bond Traders Load Up on Bearish Wagers as Rate-Cut Odds Dwindle_4

SOFR Options Most Active

Over the past week, the most active option has been in the 95.00 strike in tenors out to Dec24. Tuesday’s flows have included a buyer of the Sep24 95.00/95.25/95.50 call fly, targeting roughly 50 basis points of rate cuts being priced into the September policy meeting. The popular theme last week was targeting the Fed to skip a June rate cut via expressions such as the Dec24 95.625/95.50/95.25/95.00 “broken put condor.”

Bond Traders Load Up on Bearish Wagers as Rate-Cut Odds Dwindle_5

SOFR Options Heat-Map

The most populated SOFR strike out to the Dec24 tenor remains the 95.50 targeting a 4.5% yield, where a heavy amount of risk can be seen in the Jun24 calls, Sep24 calls and Dec24 puts. Other populated strikes include the 95.00, 95.25 and 94.875 levels, where both Jun24 calls and puts are highly populated.