EUR GBP - FUNDAMENTAL DRIVERSEUR
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
Accelerating policy normalization, but just don’t call it that. The March ECB meeting saw the ECB surprise markets by speeding up their normalization pace with the APP set to increase to EUR 40bln in April and then lowered to EUR 30bln in May and EUR 20bln in June, with an aim of ending APP in Q3. This was quite a shift, and alongside 2024 HICP expected at 1.9% it meant a hike for 2022 is still on the table. However, even though the statement was hawkish, the ECB tried very hard to come across as dovish as possible, no doubt trying to get a soft landing. The bank broke the link between APP and rates by saying hikes could take place ‘some time’ after purchases end (previously said ‘shortly’ after they end). President Lagarde also stressed that the Ukraine/Russia war introduced a material risk to activity and inflation (and it’s too early to know what the full impact of this will be). As a result, she stresses more than once that their actions with the APP should not be seen as accelerating but rather as normalizing (pretty sure going from open-ended QE to done in the next quarter is accelerating but maybe owls play by the different rules). To further add dovishness Lagarde also said that the war in Ukraine means risks are now again titled to the downside, compared to ‘broadly balanced’. After the meeting STIR markets and bund yields jumped to price in close to 2 hikes by year-end again, but the dovish push back from Lagarde saw the EUR come under pressure, failing to benefit from higher implied rates.
2. Economic & Health Developments
Growth differentials still favour the US over EU capital flows, but differentials have turned positive against the UK. Given growing stagflation fears the ECB is in a tough spot, possibly being forced to normalize policy to try and combat inflation but could as a result damage growth. Ongoing EU fiscal discussions to possibly allow ‘green bonds’ NOT to count against budget deficits remains in focus, alongside debt issuance for energy purchases. If approved, it will offer a flood of fiscal support which would be positive for the EUR and EU equities. Geopolitics The EUR pushed lower aggressively after initial geopolitical scares but have been trying to carve out a base. Proximity to the war and the impact of sanctions remains a risk if the situation deteriorates. With the already priced, chasing the lows on bad news is not as attractive as chasing the EUR higher on good news.
3. CFTC Analysis
CFTC data gave very little sentiment signals with mixed positioning changes as upside in Large Specs and Leveraged Funds was mostly offset by a hefty reduction in net longs from Asset Managers.
4. The Week Ahead
Focus for the EUR will be on the outcome of Sunday’s 1st round of the French election and the ECB. For the election, there are 4 possible scenarios, Macron gets >50% to claim victory before 2nd round voting (EUR positive), Macron leads Le Pen with comfortable margin but not enough to claim victory (EUR positive but in line with consensus), Macron leads Le Pen with very tight margin (EUR negative), Le Pen leads Macron with any margin (expected to be very negative for EUR as is most unexpected outcome). For the ECB, after their more hawkish shift on QE in March where the bank accelerated their normalization path (but according to Pres Lagarde we’re not allowed to call it that ), markets are not expecting any new surprisesfor the April decision. However, the question is how the bank’s tone and language has evolved with HICP inflation jumping to 7.5% in March (and expected to possibly reach >10% before peaking). Will inflation be enough to urge more hawkish language from the hawks or will the risk of hiking into a possible stagflation slowdown cause enough angst from the doves to urge for a more patient stance. With the uncertainty on the geopolitical side and the wide range of possible outcomes, it seems unnecessary that the bank would anything right now. They are expected to reiterate their APP plans announced in March to reduction announced in March (increasing APP to €40bn in April, then reducing to €30bn in May, reducing down to €20bn in June and with a possible end in Q3).
GBP
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In March the BoE hiked rates by 25bsp as expected but delivered a bearish hike with BoE’s Cunliffe dissenting by voting to leave rates unchanged. This was a stark change from February where 4 members voted for a 50bsp hike. Cunliffe noted the negative impacts of higher commodity prices on real household incomes and economic activity as the main reason for his dissention, while remaining members thought a 25bsp hike was appropriate given the tight labour market and risks of second round effects. Even though inflation forecasts were upgraded to 8% in Q2 (previous 7.25%), the negative view that GDP was expected to slow to subdued rates showed growing concern of stagflation. The most bearish element of the statement was a change in language regarding incoming rates where the bank said they judge that some further modest tightening MIGHT be appropriate where previous guidance said more tightening was ‘LIKELY TO BE’ appropriate (a clear push against overly aggressive rate expectations). They further pushed back by noting the current implied rate path would see inflation would be below target in 3 years’ time, in other words saying they won’t hike as much, and confirms our estimates that policy reached peak hawkishness in February. The 100% odds of a 25bsp in May drifted to just above 80% on Friday, and markets will pay close attention to incoming BoE speak, where further push back against rates could be enough to see markets pricing out some of the >5 hikes still priced for 2022. As a result of the clear dovish tilt, we have adjusted our assessment of the bank’s policy stance to NEUTRAL.
2. Economic & Health Developments
With inflation the main reason for the BoE’s recent rate hikes, there is a concern that the UK economy faces stagflation risk, as price pressures stay sticky while growth decelerates. That also means that current market expectations for rates continues to look way too aggressive even after the BoE’s recent push back. This means downside risks for GBP if growth data push lower and/or the BoE continue to push their recent dovish tone.
3. Political Developments
Political uncertainty is usually GBP negative, so the PM’s future remains a risk. If distrust grows question remains on whether a no-confidence vote can happen (if so, short-term downside is likely), and whether he can survive the vote (a win should be GBP positive and a loss GBP negative). The Northern Ireland protocol remains a focus, with previous UK threats to trigger Article 16 and EU threats to terminate the Brexit deal if they do. Markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.
4. CFTC Analysis
CFTC data for Sterling is very interesting with growing divergence between participant positioning as Large Specs and Asset Managers sit on sizeable (and growing) net shorts while Leveraged Funds continue to increase net longs. With fast money (Leveraged Funds) pushing higher and Asset Manager net-short reaching bottom 20 percentile levels (2007 used as base year) one of these two are on the wrong side.
5. The Week Ahead
Labour and CPI data will be the main data highlights for the UK this week. For inflation our same concerns as the March data print are in focus where a higher-than-expected print might not necessarily be seen as a positive. Usually, higher inflation should be a positive for the currency as it means more chances of higher interest rates. However, the bank has been clear that there is a trade-off between inflation and growth and has explained their reluctance to deliver on STIR expectations for much higher rates. Thus, higher rates would not necessarily lead to higher rate expectations but instead could be seen as a negative with stagflation risks in
view. For the labour print, it might be tricky to trade as the question will be on whether markets focus on real household incomes or second-round effects. The BoE has been very concerned with second-round effects which means higher-than-expected earnings ‘should’ increase inflation expectations which could be seen as a negative for Sterling as explained. However, if the focus is on real household incomes increasing as a result of much higher average earnings that could be seen as a positive. Recall that the main reason for Cunliffe’s dissent in March was due to inflation’s impact on real household incomes. That means labour data could be a tricky one to navigate for Sterling on Tuesday.
