Dubai Financial Market at Highest Point in Nearly Eight Years as UAE Draws Investors

The Bank of England (BoE) is facing a challenging dilemma as rising market expectations for a higher Bank Rate could potentially lead to financial instability and pose risks to the country's economy. The rally in Pound Sterling, which has outperformed other major currencies this year, has been largely driven by concerns over inflation and the market's response to potential interest rate hikes.

Governor Andrew Bailey acknowledged the signs of cooling in the labor market during a press conference, emphasizing that current levels of wage increases are not in line with the inflation target. The Consumer Price Index (CPI) inflation measure in the UK has not fallen since March, while core inflation has even risen. Adding to the concerns, measures of wage growth and unemployment have increased, further fueling expectations of a potential Bank Rate hike.

The Office for National Statistics reported a rise in the unemployment rate to 4% in the three months leading up to May, along with an increase in wage growth. Interest rate swap markets are now implying a high probability of the Bank Rate being raised from 5% to 6.5% by early next year. These implied rates have surpassed the peak of 6% assumed by the BoE in its stress test conducted as part of the latest financial stability review.

While the BoE's analysis suggests that the financial system can handle a Bank Rate of up to 6%, the increase in unemployment poses a potential challenge. Employment levels are considered a lagging indicator of economic health, but with unemployment on the rise, there is a possibility of further increases in the coming months.

The consequences of rising unemployment could have a significant impact on the banking sector, with loan defaults compromising assets and capital reserves. This presents a vulnerability for both the economy and financial stability. Additionally, the rally in Pound Sterling, driven by market expectations of higher interest rates, could be undermined if these risks materialize.

The duration of these emerging risks and their potential to undermine the Pound's rally remain uncertain. It is also unclear how long the interest rate swap market activity will continue to be self-defeating. However, the July financial stability report and recent economic data highlight the growing risk of an accident in the economy.

As the Bank of England prepares for its August forecast and interest rate decision, it will need to carefully assess all available information. Balancing the need to control inflation and support economic growth while mitigating financial stability risks will be a complex task for policymakers. The evolving situation calls for a cautious approach and close monitoring of economic indicators to navigate potential challenges and seize opportunities in the financial markets.

The oil market continued its move higher yesterday, which saw ICE Brent not only break above US$80/bbl, but settle above this level. As a result, Brent has finally broken out of the range it has spent almost two months trading in. The key catalyst for the move was U.S. CPI data coming in below consensus. And while the data is unlikely to change expectations for the Fed to hike at its next meeting, it does call into question the need for further tightening after the July meeting. While the fundamentals continue to support the view that oil prices should trend higher over the remainder of the year, there are still clear macro concerns in the market. In addition, in the very short term, the 200-day moving average is likely to provide some strong resistance to the market.

According to Argus, Russian Urals are now trading slightly above the US$60/bbl G7 price cap for shipments from Black Sea ports. Western insurance and shipping services can only be used for Russian crude priced under the cap. Obviously, there is nothing stopping this crude oil from moving with the use of alternative ships and insurance. And the fact that Russia has managed to secure a large amount of non-western shipping capacity does make the price cap less effective. If Urals remain above the cap for a sustained period, it will be interesting to see if it eventually has any impact on Russian export volumes.

The latest trade data from China this morning shows that crude oil imports averaged 12.67MMbbls/d over June, up 4% month-on-month and 45% higher year-on-year. Obviously imports were under pressure last year due to Covid related lockdowns. Meanwhile year-to-date crude imports are up 11.7% YoY.

Yesterday's EIA report saw some big inventory builds in crude and products. Commercial U.S. crude oil inventories increased by 5.95MMbbls over the last week, which was quite a lot more than the 3MMbbls increase reported by the API the previous day. The crude build was largely driven by lower exports with crude oil exports falling by 1.76MMbbls/d week-on-week to 2.14MMbbls/d, which is the lowest weekly export number since January. On the product side, distillate fuel oil inventories increased by 4.82MMbbls, whilst there was little change in gasoline stocks. Meanwhile, refinery run rates increased by 2.6pp over the week to 93.7%. Overall, the report was on the bearish side, given the large builds and weaker implied demand. However, clearly the market was more focused on U.S. CPI data yesterday.

Both the IEA and OPEC will be releasing their monthly oil market reports today, which will include their latest outlook for the oil market. Despite broader macro concerns, last month the IEA remained constructive on the demand picture, with the agency forecasting oil demand to grow by 2.4MMbbls/d in 2023. However, the agency believes the macro picture will provide more headwinds for demand in 2024, with demand estimated to grow by 860Mbbls/d next year.

European natural gas prices continue to come under pressure. TTF settled more than 8% lower yesterday and front month prices have traded down to their lowest levels in more than a month. Norwegian gas flows continue to edge higher from the lows seen in late May and over much of June (due to maintenance), whilst European storage is more than 80% full at the moment, well above the average of 65% for this time of year. Prices are likely to remain under pressure through the summer with storage expected to be full well ahead of the heating season. The Asian market is more profitable for LNG, with Asian spot LNG prices trading at its largest premium to TTF since January- more than US$3/MMBtu.

The USDA's latest WASDE report was a largely bearish affair, particularly for corn and soybeans. The USDA revised up its U.S. corn production estimate by 55m bushels to 15.32bn bushels, on the back of a larger than expected planted area as reported in its recent acreage report. A reduction in yield estimates (due to recent dry weather) was not enough to offset the higher acreage. The market was expecting a larger fall in yields, therefore the USDA's production estimate was above the 15.15b bushels the market was expecting. Higher output sees U.S. ending stock estimates for 2023/24 at 2,262m bushels, up slightly from the previous forecast and above the 2,166m bushels the market was expecting. For the global balance, corn production for 2023/24 is forecast to increase by 1.7mt to 1,224.5mt, as output increases from Canada (+0.7mt) and Ukraine (+0.5mt) partially offset by reductions from the EU (-0.9mt). 2023/24 global ending stocks for corn were left largely unchanged at 314.1mt, although this was above the little more than 312mt the market was expecting.

The USDA lowered 2023/24 U.S. soybean output estimates by 210m bushels to 4,300m bushels due to lower acreage. The market was expecting further downside to soybean output, however, the agency left yields unchanged from last month. U.S. 2023/24 ending stock estimates were reduced from 350m bushels to 300m bushels, which was still well above the roughly 206m bushels the market was expecting. For the global market, 2023/24 soybean production estimates were lowered by 5.4mt to 405.3mt, which leaves ending stocks for 2023/24 at just under 121mt.

Lastly, the USDA projects U.S. wheat supplies to increase by 74m bushels to 1,739m bushels. This pushes U.S. ending stock estimates up by 30m bushels to 592m bushels, which is above the roughly 565m bushels the market was expecting. For the global wheat market, the USDA expects 2023/24 wheat production to fall to 796.7mt this season, down from an earlier estimate of 800.2mt. As a result, ending stocks for 2023/24 were lowered by 4.2mt to 266.5mt, which is less than the market was expecting.

Following a significant post-CPI sell-off, Dollar's plunge appears to be losing some momentum during today's Asian trading session on oversold conditions. However, the greenback is yet to demonstrate any considerable signs of a rebound. Investors seem buoyed by the waning likelihood of Fed extending its tightening phase beyond the imminent July interest rate hike. As it stands, Fed fund futures are reflecting less than 30% chance for further rate hikes throughout the remainder of the year. In sync with this development, major Asian stock indexes are showing considerable gains, riding on the coattails of US market rally overnight.

New Zealand and Australian Dollar are the stronger ones for today. followed by Swiss Franc. Meanwhile, Dollar, Yen and Canadian are the worst. But for the week, Swiss Franc is the top gainer at this point, helped by EUR/CHF breaking through a key near term support level. Yen is still strong as the second, but got its first place taken by the Franc. Canadian Dollar is the second worst following Dollar despite yesterday's BoC rate hike. Euro is having a slight advantage over Sterling while Aussie and Kiwi are mixed.

Technically, EUR/CHF's dive through 0.9670 support confirms resumption of whole decline from 1.0095. The structure of the fall still suggests that it's a corrective move. But deeper decline would remain in favor as long as 0.9721 support turned resistance holds. Next target is 100% projection of 0.9995 to 0.9670 from 0.9840 at 0.9515. If realized, the extended fall in EUR/CHF would make USD/CHF short a better trade than EUR/USD long.

In Asia, at the time of writing, Nikkei is up 1.40%. Hong Kong HSI is up 2.32%. China Shanghai SSE is up 0.99%. Singapore Strait Times is up 1.75%. Japan 10-year JGB yield is down -0.0080 at 0.472. Overnight, DOW rose 0.25%. S&P 500 rose 0.74%. NASDAQ rose 1.15%. 10-year yield dropped -0.119 to 3.861.

Fed's Beige Book report noted that the "overall economic activity increased slightly since late May." Notably, the level of economic development varied across the twelve districts, with five districts reporting growth, five noticing no change, and two marking modest declines.

The Beige Book described a cautiously optimistic picture for the future, stating that "overall economic expectations for the coming months generally continued to call for slow growth."

Despite the uneven growth rate, the districts generally agreed on the direction of price changes. The report noted that "prices increased at a modest pace overall, and several districts noted some slowing in the pace of increase."

Looking ahead, the report suggests that the "price expectations were generally stable or lower over the next several months".

The employment situation was characterized by a modest rise, with the Beige Book stating that "employment increased modestly this period, with most districts experiencing some job growth."

New Zealand's manufacturing sector is experiencing a continuous contraction according to BusinessNZ Performance of Manufacturing Index. The Index showed a drop from 48.7 in May to 47.5 in June, marking another month of activity below the crucial 50.0-point mark which separates expansion from contraction.

An analysis of the sub-indices revealed mixed performances across different facets of the sector. While production showed a modest rise from 46.0 to 47.5, new orders experienced a significant drop from 50.2 to 43.8. Meanwhile, employment levels decreased from 49.3 to 47.0. Both finished stocks and deliveries saw rises, from 51.6 to 52.2 and 46.1 to 50.5 respectively.

Alongside this contraction in activity, the report noted an increase in negative sentiment among manufacturers. In June, the proportion of negative comments increased to 74.5%, up from 66.7% in May and 70.3% in April. According to manufacturers, the primary negative influences on current activity are declining demand, inflationary pressures, and issues surrounding production and staffing.

BusinessNZ's Director, Advocacy Catherine Beard, pointed out the persisting contraction in the sector, saying, "the sector remains entrenched in contraction, with eight of the last ten months showing overall activity below the 50.0-point mark."

China's trade dynamics in June spun a story of steeper than expected declines on both the import and export front. With the largest export drop since February 2020.

June's figures reveal a -12.4% yoy slump in China's exports, far exceeding anticipated -9.5% yoy decline and outpacing May's -7.5% yoy drop. Imports followed a similar pattern, decreasing by -6.8% yoy, steeper fall than projected 4.0% and more significant contraction than May's -4.5% yoy shrinkage.

Despite these challenges, China's trade surplus managed to grow from USD 68.1B to USD 70.62B. However, this increase didn't quite hit expectation of a USD 74.8B surplus.

Lu Daliang, a spokesperson for China's customs bureau, cautioned that the nation's trade is expected to face substantial pressure in the second half of the year. During a press conference, Lu attributed these pressures to high inflation in developed countries and geopolitical issues.

UK GDP, production and goods trade balance; Eurozone industrial production, and ECB meeting accounts are the main highlights in European session. US will release jobless claims and PPI later in the day.

USD/CHF hits as low as 0.8650 so far today and intraday bias stays on the downside. Current fall should target 100% projection of 0.9439 to 0.8818 from 0.9146 at 0.8525 next. On the upside, above 0.8762 minor resistance will turn intraday bias neutral and bring consolidations first. But outlook will remain bearish as long as 0.8900 support turned resistance holds.

In the bigger picture, the break of 0.8756 (2021 low) indicates break out from the long-term range pattern. For now, medium term outlook will stay bearish as long as 0.9146 resistance holds. Further fall would be seen to 61.8% retracement of 0.7065 (2011 low) to 1.0342 (2016 high) at 0.8317 next.

The Bank of Canada has raised rates a further 25 basis points today, leaving it at 5%. This follows a five-month pause between the January hike and the restart of policy tightening in June, triggered by concerns that demand was proving to be more resilient and inflation more persistent than the BoC had expected. This argument was used again today with the BoC stating that “three-month rates of core inflation running around 3½-4% since last September, underlying price pressures appear to be more persistent than anticipated. This is reinforced by the Bank's business surveys, which find businesses are still increasing their prices more frequently than normal”.

The BoC also place a heavy emphasis on the strength in consumer demand and the tightness in the labour market, which is keeping wage pressures elevated. It sees inflation staying around 3% for the next year before only returning to target in 2025. The BoC offer little in the way of forward guidance, merely stating that the “Governing Council will continue to assess the dynamics of core inflation and the outlook for CPI inflation. In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the 2% inflation target”.

The chart above shows that inflation and the unemployment rate are moving in the direction the BoC would like to see, but clearly it isn't happening quickly enough and may not be sustainable enough for the BoC to keep rates at 5%. The market is currently pricing around a 75% chance of another hike at the September meeting and we feel this is about right. The tone of the statement suggests the BoC are not convinced it has done enough yet so we will need to see significant softness in activity, labour and inflation numbers to prevent another move.

The market reaction to the BoC hike was – as we had expected – positive for the loonie, although the proximity to the surprisingly soft CPI print in the U.S. meant that CAD lagged other pro-cyclical currencies on the day. That, once again, boils down to the rather tight correlation of the loonie with incoming data from the US.

Looking beyond the very short-term impact, the extra hike by the BoC and no pushback against further moves in the future means that CAD can keep benefitting from an attractive carry. It's worth remembering that the loonie has the best volatility-adjusted carry in the G10 space. We don't necessarily see this as the inception of a broader USD downtrend, but the close USD-CAD correlation also means that CAD is more shielded in the event of a USD rebound than other pro-cyclical currencies. A move below 1.3000 is surely possible in the coming weeks, although we may need to wait the fourth quarter of this year to see USD/CAD sustainably trade around 1.27/1.28.

We saw another day of strong gains for European markets yesterday, with the FTSE100 undergoing its best one-day gain since early June, after U.S. CPI came in below forecasts.

U.S. markets also saw strong gains with the S&P500 and Nasdaq 100 breaking above their highs of this year, and pushing up to their highest levels since April 2022, with the Nasdaq 100 leading the gains.

Asia markets followed suit with strong gains across the board despite the latest set of China trade data for June showing that economic activity slowed further. Exports fell by -12.4% from a year ago, missing expectations by a large margin, while imports also declined more than expected, by -6.8%, further reinforcing concerns about deflation, but on the more positive side increasing expectations of stronger stimulus by Chinese authorities in the weeks ahead.

Yesterday's U.S. CPI numbers for June were never likely to change the calculus behind another 25bps rate hike when the Fed meets in two weeks' time, but they have altered the story when it comes to what might come next, and it is this that markets are reacting to, with the U.S. dollar and yields falling back sharply.

The nature of yesterday's numbers suggest that whatever other Fed officials would have us believe in the context of their current hawkishness, further rate hikes beyond this month will be a big ask, and probably won't happen, hence the weakness seen in both the U.S. dollar, and U.S. yields seen so far this week.

That said we can still expect Fed officials to continue to adopt a hawkish tone on the basis that they won't want markets to prematurely start pricing in rate cuts, and will want to keep the option of further hikes very much on the table.

Nonetheless the shift seen in the last few days does help to explain why the U.S. dollar has slipped so much against the Japanese yen, although some are suggesting it is because we might see a policy shift from the Bank of Japan when it meets at the end of this month. Whichever way you come at it from, the net effect is likely to be the same, in that U.S. and Japanese rates are likely to converge, rather than diverge.

Today's PPI numbers for June are expected to reinforce the disinflation trends being seen rippling out through the global economy. On the headline numbers PPI is expected to see another sharp slowdown from 1.1% in May to 0.4% in June, while core PPI is forecast to slow down more modestly from 2.8% to 2.6%.

Whichever way you look at it, further weakness here is likely to trickle down into the CPI numbers in the coming months, and reinforce the disinflationary narrative, but more importantly signal that U.S. rate hikes are done bar the move in two weeks' time.

Yesterday's U.S. inflation numbers could prove to be good news for UK homeowners, if yesterday's move in UK yields is any guide, in that they might reduce the pressure on the Bank of England to be more aggressive in terms of their own rate hiking policy.

If this month's expected July hike from the Federal Reserve is in fact the last one, then the Bank of England may only need to do another 50bps in August before similarly signalling a pause, which means that UK current terminal rate pricing is too high. This would be an enormous relief for mortgage holders worried that the base rate might rise as high as 6.5%.

The problem for the UK is the energy price cap is keeping inflation levels way too high, and now it has outlived its usefulness it really ought to be scrapped. It was useful in containing the upside, however by way of its design its not reflecting the sharp declines in gas prices in the last 12 months.

Consequently, it is contriving to exert upward pressure on wages as consumers struggle with the higher cost of living due to energy prices not coming down quickly enough.

This failure is likely to be reflected in today's UK economic data for May, which is expected to see manufacturing and industrial production to sharp 0.4% declines in economic activity for both.

The monthly GDP numbers for May are also forecast to show a -0.3% contraction due to the multiple bank holidays during the month, as well as widespread public sector strike action, with index of services seeing a sharp slowdown from 0.3% in April to -0.2%. The weak performance in May is likely to act as a sizeable drag on Q2 GDP, although we should see some of that recovered in June.

EUR/USD – broke higher through the highs of this year and could well retest the highs of March 2022 at 1.1185. This becomes next resistance, with a break targeting the 1.1485 area, with support now at 1.1020.

GBP/USD – has encountered resistance at the 1.3000 area. We need to see a break above 1.3020 to target a move towards 1.3300, and the March 2022 highs. Support now comes in at the 1.2850 area.

EUR/GBP – failed again at the 0.8500 area, with the rebound currently holding below the 0.8570/80 area. A break above here targets the 50-day SMA which is now at 0.8610.

USD/JPY – slid down to the 138.15 area where we have cloud support. If this gives way, we could see further losses towards 137.20. We now have resistance back at the 140.20 area.

The Pound to Dollar exchange rate (GBPUSD) experienced a significant rally, surpassing the psychologically important level of 1.30. This surge was triggered by the release of data indicating a sharp decline in U.S. inflation, which alleviates pressure on the U.S. Federal Reserve to raise interest rates beyond the anticipated hike in July.

The rally in GBPUSD is noteworthy, as the last time the exchange rate reached the 1.30 milestone was in April 2022 when it was heading in the opposite direction.

The data released by the U.S. Bureau of Labor Statistics (BLS) revealed a rapid cooling in inflationary pressures in the largest global economy. However, despite the decline, the slower decrease in core inflation readings suggests that the Federal Reserve will not be deterred from raising interest rates at least one more time.

Here are the key inflation figures from the BLS:

Core CPI (year-over-year) in June: 4.8%, estimate: 5.0%, previous: 5.3%

Core CPI (month-over-month) in June: 0.2%, estimate: 0.3%, previous: 0.4%

CPI (year-over-year) in June: 3.0%, estimate: 3.1%, previous: 4.0%

CPI (month-over-month) in June: 0.2%, estimate: 0.3%, previous: 0.1%

The drop in inflation was partially influenced by base effects, as a strong increase from a year ago was no longer factored into the calculations.

Following the release of the inflation data, the Pound to Dollar exchange rate rallied back to 1.2955, reversing its downward trend earlier in the day.

Meanwhile, the Euro to Dollar rate also advanced by half a percent to 1.1062. The U.S. Dollar weakened against most major currencies as U.S. bond yields declined, reflecting the belief that the Federal Reserve is gaining control over inflation.

Encouragingly for the Fed, there was relief in the preferred measure of core services prices, which excludes the impact of shelter prices. This measure provides a better gauge of underlying price pressures tied to demand. In June, it showed a -0.01% month-over-month pace, indicating that past rate hikes are starting to cool inflation.

The expectations of cooling inflation bolstered demand for U.S. Treasury bonds, leading to a decrease in the yields they offer. The 2-year yield eased further below the symbolic 5% barrier.

The Dollar's weakness following the CPI release comes as GBPUSD aims to extend its multi-month rally towards, and potentially beyond, the 1.30 level.

Pound bulls may need to wait for the market to settle before they are able to get back into the market, however, according to analysts and technical studies.

According to analysts, breaking the 1.30 level will be challenging for Pound Sterling, which is starting to appear overextended after its recent rally. It is advisable to exercise caution, as after a strong rally this month, breaking 1.30 could be difficult.

In conclusion, the Pound's surge against the Dollar was fueled by easing U.S. inflationary pressures, which relieved some pressure on the Federal Reserve to aggressively raise interest rates. While the 1.30 level presents a challenge, the Pound's rally demonstrates its strength. Investors will closely monitor further developments in inflation and central bank policies as they navigate the foreign exchange market.