FX outlook: Parky’s quick take – 23 August 2021

23 August 2021

Neil ParkerFX Markets Strategist

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GBP drops amidst weaker data
What did last week show us? There was an improvement in the UK labour market figures, with employment rising almost 100k in the 3 months ending June, average earnings up to an all-time high, and the International Labour Office (ILO) unemployment rate dropping to a post pandemic low. That though was the only positive activity data released, with the retail sales figures at the end of the week recording a sharp drop in volumes in July, as the choice for consumer spending continued to widen.

There was also weakness from the July consumer price inflation figures, which recorded a slower than expected rate of headline and core CPI inflation, thanks in large part to discounting in the clothing and footwear sector. The August GfK1 consumer confidence reading also dipped, as the climate for ‘making major purchases’ component dropped from July’s reading. Finally, the public finances data recorded smaller than expected borrowing in July, but the public sector net borrowing would normally print small surpluses in this month, as it coincides with quarterly tax payments from the self-employed.

The pound’s dip was driven both by the economic releases and a drop in underlying risk appetite. That drop was prompted by the fallout from the US’s and allies’ withdrawal from Afghanistan, which continued to reverberate around the markets. Concerns have continued to grow about how this might destabilise the region and Western economies. GBP/USD tested $1.36, and GBP/EUR tested €1.1650, with the UK data and surveys ensuring that the dip in risk appetite most severely impacted on sterling.

This week may prove little different. The provisional August PMIs2 have already been released and show that the UK manufacturing and services sectors are slowing, albeit only marginally in the case of the UK manufacturing sector. The slowdown in services looks more troubling, if it is confirmed by the official data, since it is services that provide the rump of growth. The composite reading of 55.3 was still favourable versus pre-COVID readings, but much less so than before. The CBI industrial trends survey for August, also already released, recorded an unexpected improvement in headline orders, but with the news also that price rises were even more commonplace across industry. Overall, the net effect of these releases on the GBP was mildly negative and counteracted the improvement in risk appetite seen at the beginning of the week.

The only other release this week is the CBI distributive trades survey for August. This is released on Wednesday at 11:00am and should record a slowing in activity rates in retail. None of these releases have the power to turn the tide, which is currently against the GBP, back in its favour. It will take something more significant either from the UK or other economy’s authorities to reverse recent trends.

US Federal Reserve ever closer to beginning the taper; Jackson Hole is the next key event

Amidst a week of mixed data and surveys from the US, last week saw the Federal Reserve’s July meeting minutes reveal that more Fed members were in favour of tapering the asset purchase programme over the coming months. That didn’t mean it would start at the next meeting, scheduled for 22nd September, although this is a significant risk, but by the end of the year the programme to reduce asset purchases ought to be underway, and it should be a relatively short-lived process. The prospect of a tapering of asset purchases, coupled with the increased geopolitical risk from Afghanistan, drove equity markets lower and strengthened the US dollar, but the bond markets saw yields drop as well, suggesting that the reduction in risk appetite prompted by geopolitical events outweighed the taper risk.

There is also the ongoing issue of who will head up the Federal Reserve come next year? After the debacle of the Afghanistan withdrawal does Biden want another battle with the other arms of government, particularly the knife edge Senate to get a different candidate confirmed, if he chooses not to select current Chair Jerome Powell for a second term? Any unnecessary turmoil could prompt some USD weakness.

This week, there are few major data releases due. There may be interest in provisional August manufacturing and services PMIs on Monday, existing and new home sales figures due late on Monday and Tuesday respectively, revised Q2 GDP figures on Thursday, July personal income and spending figures on Friday and, late on Friday, final August consumer sentiment figures from the University of Michigan. None of these figures should provide much direction to the USD, but the Fed’s Jackson Hole symposium, from 26-28 August could.

What will the speakers say regarding the post pandemic response? Could the argument be made for an earlier and more aggressive start to the Fed’s taper programme, and what about the need for higher interest rates to deal with any sustained domestic inflation pressures?

Euro declines again

The euro was under pressure again last week, dropping back below $1.17. The limited data from Euroland pointed to some surprising strength from Q2 employment, and it was surprising given that for much of Q2 renewed restrictions or lockdowns were in place for a number of the key major Euroland economies. The other figures were as expected, with GDP growth confirmed at 2% q/q3 in revised Q2 GDP figures, whilst final July consumer price inflation data recorded a 2.2% y/y4 rate, in line with expectations.

The decline in the euro against the US dollar was not matched in EUR/GBP, which rose throughout the week. That strongly suggests the moves were dollar related and that the euro fared better than other risk-positive major currencies. Not only did EUR/GBP move higher, but the likes of EUR/CAD and EUR/AUD rose sharply, demonstrating the move was risk-averse driven.

This week, we’ve already had the Euroland provisional August PMIs for manufacturing and services. These showed activity levels in services well in excess of those in the UK, whilst manufacturing activity remained at elevated rates also. This news is likely to be viewed positively by the markets, but is perhaps also because many of the European economies re-opened later than the UK’s. So will the outperformance last, and what will that mean for the euro? The German IFO business climate survey for August is released on Wednesday and forecast to record a slight weakening in the underlying business climate, although could outperform. On Thursday, French business confidence for August and Euroland July M3 money supply figures are released and could again surprise against expectations. Finally, on Friday Italian consumer and manufacturing confidence figures for August are expected to record a small drop in both indices. Could a collection of stronger figures from Euroland surveys support a rebound in the EUR? Perhaps not, but they could help the EUR find a base against other majors.

Central Banks – RBNZ holds rates after COVID case; Hungary to hike this week

Last week’s key central bank meetings included the Reserve Bank of New Zealand, Bank of Indonesia and Norges Bank. The RBNZ was expected to raise interest rates to 0.5% from 0.25%, but after a single case of COVID was uncovered, the three-day lockdown and downside risks to activity prompted the central bank to change course and leave policy on hold. That could be only a temporary reprieve, with the next meeting, on 6th October, likely to reinstate the hike, if by that point restrictions have been lifted and not reinstated. The Bank of Indonesia left policy on hold, seeing little room to reduce interest rates in the shadow of potential Fed tapering and with the rupiah weakening somewhat. As for Norges Bank, it left strong hints that, barring any resurgence of COVID infections, a hike in late September was highly likely.

This week sees central bank meetings from Israel, Hungary and South Korea. Only the Hungarian central bank is expected to hike interest rates, with higher inflation and a strong recovery the driving forces behind another 30 basis point hike, after the same size hike in June. As for the Bank of Korea, there has been a solid recovery in the economy, but there is not enough reason for the BoK to hike yet.

1 GfK Growth from Knowledge
2 PMI Purchasing Managers' Index
3 q/q Quarter on quarter
4 y/y Year on Year 

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