FX Focus: What Brexit chaos means for sterling

The week ahead is set to tell us a great deal about the US dollar's (USD) value. A range of data releases as well as some technically strong levels should determine whether the path of the USD (higher) can be maintained at what has been break-neck pace up until a few weeks back, or whether some much welcome consolidation can develop.  

Friday's price action suggested so, but month end flows can distort this view, so it is best to reserve judgement once the commercial flow is out of the way.  

One notable theme from the end of last week was a revival in risk sentiment and, despite reports of sizable outflows from equities, another recovery on Wall Street put pressure on certain currencies - namely the Japanese yen (JPY).  

Losses were suffered across the board, with EUR/JPY and GBP/JPY posting the strongest gains on the day, outpacing USD/JPY which continues to find resistance ahead of 111.00.  This naturally gave the respective spot rates a large helping hand, with both EUR/USD and Cable up 1% on the day.  

Monday has seen the market revert to type, with some early gains in the greenback, though, as yet, we expect this is little more than some readjustment to Friday's moves. 

Global trade is clearly in murky waters at the present time, as the US administration is intent on pursuing its aim of restoring tariff imbalances it sees largely against China and Europe. The implications will be felt further down the road as we wait to see which set of dynamics impact on the affected economies. 

Right now, the commodity linked currencies have been feeling most of the heat as raw materials prices have come under the cosh. Copper prices as a benchmark correlation with Aussie dollar (AUD) continue to hover above eight-month range lows, and this would lead to further AUD/USD losses through the tentative support seen in the 0.7325-50 area.  

Past performance is not a guide to future performance 

The Reserve Bank of Australia (RBA) is the only central bank who meet this week, but domestically, the baseline scenario is unlikely to change much other than that in respect to the external forces - a trade war - impacting on exports.   

Chinese manufacturing and services PMIs were out over the weekend, and a minor dip in the former should not be a major concern at this point, with services moving up (slightly) the other way.  

As above, the focus will be on the US data, headlined by the June employment report on Friday.  Wages should continue to be more of a factor here, and, indeed, if we see pick up in the earnings rate, then any miss on headline gains will likely be viewed as a function of the economy running close to full employment.  

As such, expectations for wage growth to accelerate may also gain traction despite the naysayers at the Federal Reserve, including the key proponents Bullard and Kashkari.  

While markets have chosen to disregard comments from these Fed quasi-doves, there may be validation in questioning their outlook on rates and, thereon, the level to which this has been priced in to the USD.  

At 95.50, the USD index looks to have hit a wall, but this has not stopped the market from maintaining a 'buy on dips' mentality, with some of this seen at the start of the week as alluded to above.  

Survey data in the form of the ISMs see manufacturing covered on Monday and services Wednesday, but, as above, US jobs will be the main event.  Other data worthy of note include the May factory orders stats, and naturally the ADP private jobs release which is the usual precursor to non-farm payrolls.  

All the while the markets will have to negotiate the stream of headlines over trade and tariffs, with the US president taking a swipe at Europe over the weekend, claiming they are 'as bad as China, only smaller'.  

Once again, risk assets brush this off, with this kind of immunity well established in the equity markets, and watching the ongoing sell off in gold, placing money into US paper seems to be the preferred choice given the US economic outlook and its status as a reserve (safe haven) currency.  

Consequently, USD/JPY is still trying to push higher, though selling interest ahead of 111.00 is not giving up. There are further notable levels into the 111.75-112.00, with some notable trend line resistance kicking in just below here.  

From a JPY perspective, the Bank of Japan’s (BoJ) ongoing asset purchasing program continues to weigh on the currency, but last week we saw slightly reduced amounts of buying in the 5-10yr which some pundits described as 'stealth tapering'.  

Maybe. What the BoJ have to consider is how long they can continue this 'powerful easing' as they call it, with debt to GDP now well over the 250% and climbing - all the while doing little to spur inflation.  Something isn't working, but any change to their current stance could see the JPY snap back (higher) with a vengeance - especially with JPY shorts building up again.  

Past performance is not a guide to future performance 

For EUR/USD, the signs are obvious.  US economic divergence from the eurozone coupled with political ripples all over Europe make the pair an obvious sell.  

Over time, there is every reason to below the pair can delve back into the 1.0900-1.1400 zone, which held firm for much of 2016 before the market started calling for parity.  This spread into early 2017, but by the end of year, 1.2000, 1.2500 and 1.3000 were the calls from the market, before finally US growth and inflation started to pick up.  

We are now back in the middle of that broader range - hence the brief history lesson - and we sense this level of moderation is largely behind the support seen into 1.1500.  A move back up to 1.2000-1.2200 would not disrupt the downtrend seen here, but markets are tripping over themselves to sell again, so no surprise that there are fears of a near-term short squeeze. 

Past performance is not a guide to future performance 

For the pound, Brexit optimism has swiftly turned into pessimism again, but some were expecting this as the clock ticks down towards March 2019.  

Little progress on a customs arrangement, which has major implications for Ireland and Northern Ireland, have set off jitters again, and Cable is looking down the barrel once more, with the 1.3000 level hanging in the balance again (see chart below). 

Past performance is not a guide to future performance 

The market is also taking a more sanguine approach to any rate hike the Bank of England (BoE) may choose to opt for this year, and there remain plenty of calls for them to stay on hold.  

BoE dove Cunliffe, speaking over the weekend, claimed there is more pain to come, and if some of the warnings by major enterprises tied closely to Europe follow through on their fears, GBP sales are going to pick up again.  

No doubt the government know this, and Theresa May has had the unenviable task of uniting the government on a credible plan to put forward to the European Union (EU). She meets with the Cabinet to try and finalise a White Paper, which was delayed until after the EU Summit last week.  

The data in the meantime will be cold comfort, with business investment now core to the fortunes of GBP.  EUR/GBP buying has been pretty consistent in recent weeks, so any Brexit breakthrough (here's hoping) will be reflected significantly here, where the cross rate is nearing some key levels from 0.8900 up.  

Past performance is not a guide to future performance 

Finally, as Canada enjoys a brief spell out of the limelight - president Trump focusing on Europe and China more recently - the Canadian dollar (CAD) has made back some ground with the aid of higher oil prices.  

Twice the spot rate has tested the 1.3380-1.3400 zone with a view to challenging the psychological 1.3500 mark, and some are suggesting 1.4000 is also on the horizon based on the imposition of tariffs (both ways) with the US.  

NAFTA will have to wait, but on the domestic front, the July Bank of Canada (BoC) is in focus as the market weighs up whether Poloz and Co will tighten again.  Some are expecting a dovish hike at best, but consistent has been the BoC rhetoric that the economy is running closer to full capacity and Friday's jobs report will see whether this is translating into further hiring.   

1.2950-1.3050 is a key area on the downside in USD/CAD, and last week's move into the lower 1.3100's suggested some are keen to test this.  

Past performance is not a guide to future performance