GBP caught wrong footed; Profit taking across US Treasuries

The British pound is at risk of giving up gains versus the USD. US yields rise as Powell downplays odds of 50bps cut in July.
Philip Wee, Eugene Leow27 Jun 2019
    Photo credit: AFP Photo

    FX: GBP to be caught wrong-footed by Fed and BOE

    The British pound is at risk of giving back the past week’s appreciation against the US dollar. The move was mostly driven by a weak USD on heightened Fed cut expectations after the FOMC meeting on June 19. The Fed has taken issue with the market’s aggressive bets for a 50 bps cut at the next FOMC meeting on July 31. Driving the US 10Y yield below the Fed’s 2% inflation target was inconsistent with the Fed’s message that any rate cut should be viewed as an insurance move to cushion the US economy against global risks, namely, another escalation in trade tensions.

    To make matters worse, GBP bulls are also caught off-guard by the Bank of England’s dovish tilt. BOE Governor Mark Carney has leaned towards rate cuts in the event of a no-deal Brexit. Given the recent domestic political developments, Carney probably felt obligated to remind markets that BOE’s forecasts have assumed a smooth Brexit. Boris Johnson, who is the frontrunner to succeed Theresa May as prime minister in July, has been pushing a “Believe in Britain” mantra, and predicted a “million-to-one” chance of the UK exiting the EU without a deal on October 31. In this regard, GBP bulls should pay attention to downside risks when the 10Y gilt starts trading below the 0.75% BOE bank rate.

    Rates: Profit taking across US Treasuries        
    A bout of profit taking took place across the US Treasuries curve (with short end rates bearing the brunt of the selloff) as Powell pushed back against the possibility of a 50bps cut in July. In any case, investors will want to position lightly heading into the G20 this weekend. If the outcome surprises on the upside, US yields could head higher as the market rethinks the urgency on Fed easing. However, we think there would be a cap on how high yields can go given that recent US data looks mixed and there will still be a need to price in downside risks from weaker growth across the rest of the globe. Dovish European Central Bank (ECB) policy will keep longer-term UST yields anchored for the foreseeable future.

    The divergence in monetary stance between the Fed and the ECB bears watching. At this point, Eurozone data appears to be showing clearer signs of weakness and Draghi much more willing to deliver rate cuts and quantitative easing (QE). Conversely, Powell seems more reticent and wants to guide the markets away from pricing in rate cuts too aggressively. This could play out with the EUR/USD cross currency basis swaps widening out from current levels. The last time basis swaps widened significantly was in 2014/2015 when the Fed was trying to normalize policy at a time when the ECB was running QE.  

    Philip Wee

    FX Strategist - G3 & Asia

    Eugene Leow

    Rates Strategist - G3 & Asia

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