EUR GBP - FUNDAMENTAL DRIVERSEUR
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
Hawkish sums up the ECB’s Feb decision. The initial statement was in line with Dec guidance and offered very little surprises (which was initially seen as dovish). However, during the press conference President Lagarde explained that the upside surprises in CPI in Dec and Jan saw unanimous concern around the GC in the nearterm and surprised markets by not repeating Dec language which said a 2022 rate hike was unlikely (which immediately saw STIR markets price in a 10bsp hike as soon as June). The president also made the March meeting live, by stating that they’ll use the March meeting to decide what the APP will look like for the rest of 2022 (which markets took as a signal that the APP could conclude somewhere in 2H22. After the meeting we had the customary sources comments which stated that the ECB is preparing for a potential policy recalibration in March (with some members wanting to change policy at today’s meeting already) and added that it is sensible not to exclude a 2022 hike as a possibility and also stated that the ECB is considering possibly ending the APP at the end of Q3 (which would put a Q4 hike in play). Furthermore, sources stated that if inflation does not ease, they’ll consider adjusting policy in March (which means incoming inflation data will be critical). The shift is stance and tone were significant for us to change the bank’s overall policy stance to neutral and to adjust
the EUR’s fundamental bias from dovish to neutral as well. Incoming inflation data will be key from here.
2. Economic & Health Developments
Recent activity data suggests the hit from lockdowns weren’t as bad as feared, the Omicron restrictions weighed on growth. Differentials still favour the US and UK above the EZ. The big focus though is on the incoming inflation data after the ECB’s recent hawkish pivot at their Feb meeting. On the fiscal front, attention is on ongoing discussions to potentially allow purchases of ‘green bonds’ NOT to count against budget deficits. If approved, this can drastically change the fiscal landscape and would be a positive for the EUR and EU equities.
3. Geopolitics
The Russian invasion of Ukraine opens up a lot of uncertainty for the EUR. On one hand, the decision to ban certain Russian banks from SWIFT was expected to impact the EU negatively, but the decision to freeze CBR assets means the expected FX reserve sales of Euros (to try and prop up the RUB) might not happen. The other consideration is energy, with the SWIFT bans, any restrictions on energy sales from Russia would put pressure on already high inflation and increases stagflation risks of higher inflation but falling growth. That does cloud the med-term outlook for the EUR and means we are happy to hold onto a neutral bias for now.
4. CFTC Analysis
Participants are building into EUR longs. Large specs have seen 9/10 week of net increases in longs, asset managers have seen 10/12 weeks of net increase in longs and leveraged funds have reduced net shorts for 11 weeks in a row now. It’s safe to say that the sentiment for the EUR has improved given positioning data. However, the risk here is also that a lot of new bullish sentiment could have built up at the wrong time.
5. The Week Ahead
It’ll be a difficult juggle for the EUR next week amid very important econ data and geopolitics. Monday’s open can be messy, as further sanctions on Russia over the weekend is a negative for the EUR but freezing assets from the CBR could mean less chance of dumping EUR reserves to prop up the RUB. Also keep USD liquidity squeezes in mind as a big drain on USD liquidity could see the Fed opening up swaps and could end up pressuring the USD & supporting the EUR. On the data side there will be a lot of focus on Wednesday’s HICP print. The upward surprise in Jan’s HICP was enough to see unanimous concern among the GC according to Pres Lagarde. This past week, ECB’s Lane said the Ukraine crisis presents a big risk to much higher inflation for 2022, and that comes amid already much steeper upwards projections to staff forecasts. Thus, an upward surprise to this week’s data would put more pressure on the ECB to go ahead with a possible policy recalibration at the upcoming March meeting and should be a positive input for the EUR (despite the geopolitical risks). Market implied rate expectations have dropped to just above 30bsp, which means an upside surprise in price pressures can spark some higher repricing. With so many negatives priced into the EUR over the past few months, we still hold to the view that the EUR could perform well relative to the USD and GBP if the ECB tilts more hawkish as we’ve arguably been getting very close to a state of peak hawkishness for the Fed and BoE.
GBP
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
Hawkish surprise with a hint of dovish undertones sums up the Feb BoE decision. The bank announced the start of passive QT and hiked rates by 25bsp as expected, but the vote split was unanimous (9-0) but with a big hawkish surprise being 4 MPC members voting for a 50bsp hike. Inflation forecasts saw a big upward revision to a 7.25% peak by April ( prev . 6.0%) & 5.21% in 1-year ( prev . 3.40%). This initial hawkish statement saw immediate strength for GBP but during the press conference the BoE tried their best to get a dovish landing. Gov Bailey started his opening remarks by noting that the MPC’s decision to hike was not because the economy was strong but only because higher rates were necessary to return inflation to target, and even though he opened the door for further hikes he added that markets should not assume rates are on a long march higher. He also acknowledged the stagflation fears recently voiced by some market participants by saying that policy faces a trade-off between weakening growth and higher inflation . Despite the dovish nuances, STIR markets still price an implied cash rate of 1.0% by May which would mean a 25bsp in both March and May (1.0% is the level the BoE previously said they would being outright Gilt selling). Overall, the statement was hawkish, but the clear dovish undertones from the BoE was a bit surprising and also a bit worrisome for the future outlook.
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 looks way too aggressive and means downside risks for GBP should growth data push lower, inflation stay sticky, or the BoE continue to push their recent dovish tone.
3. Political Developments
Domestic political uncertainty usually leads to higher risk premiumsfor GBP, so the fate of PM Johnson remains a focus. Fallout from the heavily redacted Sue Gray report was limited but with growing distrust from within his party the question remains whether a vote of no-confidence will happen (if so, that could see short-term downside), and then focus will be on whether the PM can survive an actual vote of no-confidence, where a win should be GBP positive and negative for GBP if he loses. The Northern Ireland protocol is still in focus with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, markets have rightly ignored this as posturing, but any actual escalation can see sharp downside for GBP.
4. CFTC Analysis
Even though recent data started to look more constructive for Sterling from a sentiment point of view, the CFTC data remains a mix bag with no clear consensus view, and nothing really stretched by any means.
5. The Week Ahead
The past week, our expectations for downside risks for Sterling materialized amid geopolitical risks but the bigger focus for us was the BoE’s hearing where the MPC struck a similar dovish tone like we saw during the press conference of the February policy decision. With close to 6 hikes already priced (possible peak hawkishness scenario), and growth expected to slow, and the BoE looking to stick to their recent dovish tones, that means the med-term risks for downside has become greater than that of further upside, and as a result we have decided to shift our currency bias to neutral from weak bullish . In the week ahead, there is very little important data on the schedule, but we do have speeches from BoE’s Saunders and Mann to watch out for. Apart from that, the ongoing geopolitical situation will be important to watch as last week’s sanctions saw outsized pressure on Sterling compared to the likes of the EUR. However, if the RUB sees enough downside and sparks deeper financial stability concerns then all European currencies are expected to be sensitive to the fallout and something to remember for the week ahead.
