Dimmer outlook for GBP and EUR; Front-end of the USD curve vulnerable to Powell

European currencies weighed by hard Brexit risks, weaker outlook and easing expectations. Bond markets are wary that Fed Chairman Powell's testimony may push back "recession cuts"
Philip Wee, Eugene Leow10 Jul 2019
    Photo credit: AFP Photo

    FX: GBP and EUR are dragging each other lower

    The British pound closed below 1.25 against the USD on July 9, at its lowest level since April 2017. The risk of a disorderly Brexit on October 31 has increased on incoming new leadership in London and Brussels. Boris Johnson has been leading the Tory leadership contest on a pledge to take the UK out of the EU with or without a deal. European Commission President nominee Ursula von der Leyen, a critic of Brexiter, has told German businesses to prepare for a no-deal Brexit. She has affirmed that the Irish border backstop would not be removed from the withdrawal agreement. Brussels wants to know what kind of future relationship the UK wants with the EU before considering any request for any extension of Article 50.

    According to a Reuters poll, a hard Brexit would take GBPUSD into a lower 1.17-1.25 range. Another extension to accommodate a second referendum could lift it back to 1.30-1.36. Except that we are still a fortnight away from the UK announcing a new prime minister. To complicate matters, the weak pound is weighing on the euro and vice versa. The EC is likely to downgrade its outlook when it publishes its Summer 2019 Economic Outlook today. The market is comfortable with the European Central Bank’s signal for more stimulus. Meanwhile, the Bank of England has already opened the door to cut rates in a hard Brexit scenario. GBP and EUR will be pressured further if Fed Chairman Jerome Powell signals a wait-and-see approach to assess the US economy’s resilience to global headwinds before deciding on rate cuts.

    Rates: Frontend of USD curve still vulnerable                               
    Ahead of Powell’s testimony to Congress, we take stock of how USD rates have adjusted since the blockbuster payrolls from last Friday. Market participants still view a July cut as the most likely scenario but have removed the possibility of a 50bps move. However, without further weakness on the macro front, “insurance cuts” should not amount to more than 2-3 over the coming few months. It may not make sense to reflect that much easing (the market still sees 3-4 cuts over the coming year) over an extended period. Accordingly, the curve has bear flattened, with the 3Y yield up by up around 17bps compared to the period before the payroll data release. Upward pressure on the longer tenors are more muted, with 10Y yields up by 12bps over the same period.

    We still think that the front of the curve (1Y-5Y) may be the most vulnerable to any hint of hawkishness (stressing patience on policy making) from Powell. If the market decides to remove “recession cuts” from its base case, there would be negative implications across all assets. Notably, the rally in government bonds and the stock market was built on the premise that the Fed will deliver significant easing, thereby justifying the lofty valuation across these markets. Bad data is good news for asset prices. Conversely, as the market rethinks Fed policy (on the back of firm payrolls), bond and equity prices have started to wobble.


    Philip Wee

    FX Strategist - G3 & Asia


    Eugene Leow

    Rates Strategist - G3 & Asia

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