EUR
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The ECB used the April meeting as a place holder meeting for the most part by not announcing any additional policy tweaks. The plans to phase out the APP into Q3 remained intact by reducing purchases from 40bln to 30bln in May and then down to 20bln in June. Markets were leaning towards a slightly more hawkish take from the bank (given recent inflation pressures), but the lack of conviction to remove the conditionality regarding the APP removal was seen as dovish. President Lagarde added to this dovish tone by explaining that Q3 has three months and IF the bank stops the APP, it could happen July, August or September. This was an important statement as the difference between a July and September end could mean the difference between a Q3 or Q4 rate hike. The president also added to the dovish tone by stressing that risks for the economic outlook are tilted to the downside and have recently intensified with geopolitical and virus-related challenges. When asked about policy normalization, the president made a strange comment by saying it is premature to think about monpol normalisation. As the bank is currently embarking on normalization this comment seemed out of place and reaffirmed the overall dovish take from the meeting. There were the usual sources releases after the presser which said policymakers see a July hike as still possible after Thursday's meeting, which provided some reprieve. With inflation >7% and growth slowing, the June meeting which accompanies staff economic projections will be critical for markets to solidify whether expectations of 1 or 2 hikes this year is correct or not.
2. Economic & Health Developments
Growth differentials still favour the US over EU capital flows, but differentials have turned positive against the UK. Given growing stagflation fears the ECB is in a tough spot, being forced to normalize policy to try and combat inflation but could as a result damage growth. Ongoing EU fiscal discussions to possibly allow ‘green bonds’ NOT to count against budget deficits remains in focus, alongside debt issuance for energy purchases. If approved, it will offer a flood of fiscal support which would be positive for the EUR and EU equities. Geopolitics The EUR pushed lower aggressively after initial geopolitical scares but have been trying to carve out a base. Proximity to the war and the impact of sanctions remains a risk if the situation deteriorates. With lots of negatives already priced, chasing lows on bad news is not as attractive as chasing the EUR higher on good news.
3. CFTC Analysis
Quite a chunky increase in long exposure from Large Specs and Leveraged Funds while Asset Managers reduced long exposure. With aggregate positioning close to 1 standard deviation above the mean positioning might look stretched, but relative to where we were coming from positioning is more bullish than bearish right now.
4. The Week Ahead
Even though the EUR saw some downside after the ECB last week, there was not much change in STIR pricing for 2 hikes this year. Thus, we would still prefer chasing the EUR higher on good news as opposed to chasing it lower on bad news with a lot of bad news already priced. That means in the week ahead the main events to watch would be the incoming S&P Global Flash PMI data, ECB speak and geopolitical developments. With the current stagflation fears any bigger-than-expected bounce or miss in the data will be important for short-term volatility, but it might not be enough to change the market’s mind about the ECB until we get the June policy meeting out of the way. Thus, even though PMIs could provide short-term directional moves it might not be enough to create sustainable moves going into the June meeting. Geopolitics will also be in focus, where Finland and Sweden’s attempts to join NATO could spark aggressive reactions from Russia (any threats from Russia could see markets pricing in a bigger risk premium for the EUR). We also need to keep energy in mind where the possibility of energy embargos on Russian oil and gas will be key to watch as well.
GBP
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In March the BoE hiked rates by 25bsp as expected but delivered a bearish hike with BoE’s Cunliffe dissenting by voting to leave rates unchanged. This was a stark change from February where 4 members voted for a 50bsp hike. Cunliffe noted the negative impacts of higher commodity prices on real household incomes and economic activity as the main reason for his dissention, while remaining members thought a 25bsp hike was appropriate given the tight labour market and risks of second round effects. Even though inflation forecasts were upgraded to 8% in Q2 (previous 7.25%), the negative view that GDP was expected to slow to subdued rates showed growing concern of stagflation. The most bearish element of the statement was a change in language regarding incoming rates where the bank said they judge that some further modest tightening MIGHT be appropriate where previous guidance said more tightening was ‘LIKELY TO BE’ appropriate (a clear push against overly aggressive rate expectations). They further pushed back by noting the current implied rate path would see inflation would be below target in 3 years’ time, in other words saying they won’t hike as much, and confirms our estimates that policy reached peak hawkishness in February. The 100% odds of a 25bsp in May drifted to just above 80% on Friday, and markets will pay close attention to incoming BoE speak, where further push back against rates could be enough to see markets pricing out some of the >5 hikes still priced for 2022. As a result of the clear dovish tilt, we have adjusted our assessment of the bank’s policy stance to NEUTRAL.
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 continues to look too aggressive even after the BoE’s recent push back. This means downside risks for GBP if growth data push lower and/or the BoE continue to push their recent dovish tone.
3. Political Developments
Political uncertainty is usually GBP negative, so the PM’s future remains a risk. If distrust grows question remains on whether a no-confidence vote can happen (if so, short-term downside is likely), and whether he can survive the vote (a win should be GBP positive and a loss GBP negative). The Northern Ireland protocol remains a focus, with previous UK threats to trigger Article 16 and EU threats to terminate the Brexit deal if they do. Markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.
4. CFTC Analysis
CFTC data had a bearish signal last week as all three participant categories saw increased short exposure for Sterling. Price action and positioning has been looking a bit stretched with Asset Managers and Large Spec netshort reaching bottom 20 percentile levels. Our preference remains to look for GBP shorts.
5. The Week Ahead
Retail Sales and S&P Global Flash PMI’s will be the main data highlights for Sterling in the week ahead. The growing fears of stagflation in the UK means the incoming growth data will be very important. Thus, what markets will want to see from the incoming data is whether there are noticeable signs that growth is slowing faster than expected. Markets are already expecting Flash PMIs to slow from prior numbers but are expecting a stronger Retail Sales print. Any bigger-than-expected miss will further exacerbate the slowing growth fears and could see some of the upside bounce in Sterling fade, while a bigger-than-expected beat could see some further recovery for the GBP. In the current stagflation context, we would prefer to trade Sterling on the short side in the event of a miss as opposed to buying it on a beat.
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
The ECB used the April meeting as a place holder meeting for the most part by not announcing any additional policy tweaks. The plans to phase out the APP into Q3 remained intact by reducing purchases from 40bln to 30bln in May and then down to 20bln in June. Markets were leaning towards a slightly more hawkish take from the bank (given recent inflation pressures), but the lack of conviction to remove the conditionality regarding the APP removal was seen as dovish. President Lagarde added to this dovish tone by explaining that Q3 has three months and IF the bank stops the APP, it could happen July, August or September. This was an important statement as the difference between a July and September end could mean the difference between a Q3 or Q4 rate hike. The president also added to the dovish tone by stressing that risks for the economic outlook are tilted to the downside and have recently intensified with geopolitical and virus-related challenges. When asked about policy normalization, the president made a strange comment by saying it is premature to think about monpol normalisation. As the bank is currently embarking on normalization this comment seemed out of place and reaffirmed the overall dovish take from the meeting. There were the usual sources releases after the presser which said policymakers see a July hike as still possible after Thursday's meeting, which provided some reprieve. With inflation >7% and growth slowing, the June meeting which accompanies staff economic projections will be critical for markets to solidify whether expectations of 1 or 2 hikes this year is correct or not.
2. Economic & Health Developments
Growth differentials still favour the US over EU capital flows, but differentials have turned positive against the UK. Given growing stagflation fears the ECB is in a tough spot, being forced to normalize policy to try and combat inflation but could as a result damage growth. Ongoing EU fiscal discussions to possibly allow ‘green bonds’ NOT to count against budget deficits remains in focus, alongside debt issuance for energy purchases. If approved, it will offer a flood of fiscal support which would be positive for the EUR and EU equities. Geopolitics The EUR pushed lower aggressively after initial geopolitical scares but have been trying to carve out a base. Proximity to the war and the impact of sanctions remains a risk if the situation deteriorates. With lots of negatives already priced, chasing lows on bad news is not as attractive as chasing the EUR higher on good news.
3. CFTC Analysis
Quite a chunky increase in long exposure from Large Specs and Leveraged Funds while Asset Managers reduced long exposure. With aggregate positioning close to 1 standard deviation above the mean positioning might look stretched, but relative to where we were coming from positioning is more bullish than bearish right now.
4. The Week Ahead
Even though the EUR saw some downside after the ECB last week, there was not much change in STIR pricing for 2 hikes this year. Thus, we would still prefer chasing the EUR higher on good news as opposed to chasing it lower on bad news with a lot of bad news already priced. That means in the week ahead the main events to watch would be the incoming S&P Global Flash PMI data, ECB speak and geopolitical developments. With the current stagflation fears any bigger-than-expected bounce or miss in the data will be important for short-term volatility, but it might not be enough to change the market’s mind about the ECB until we get the June policy meeting out of the way. Thus, even though PMIs could provide short-term directional moves it might not be enough to create sustainable moves going into the June meeting. Geopolitics will also be in focus, where Finland and Sweden’s attempts to join NATO could spark aggressive reactions from Russia (any threats from Russia could see markets pricing in a bigger risk premium for the EUR). We also need to keep energy in mind where the possibility of energy embargos on Russian oil and gas will be key to watch as well.
GBP
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
In March the BoE hiked rates by 25bsp as expected but delivered a bearish hike with BoE’s Cunliffe dissenting by voting to leave rates unchanged. This was a stark change from February where 4 members voted for a 50bsp hike. Cunliffe noted the negative impacts of higher commodity prices on real household incomes and economic activity as the main reason for his dissention, while remaining members thought a 25bsp hike was appropriate given the tight labour market and risks of second round effects. Even though inflation forecasts were upgraded to 8% in Q2 (previous 7.25%), the negative view that GDP was expected to slow to subdued rates showed growing concern of stagflation. The most bearish element of the statement was a change in language regarding incoming rates where the bank said they judge that some further modest tightening MIGHT be appropriate where previous guidance said more tightening was ‘LIKELY TO BE’ appropriate (a clear push against overly aggressive rate expectations). They further pushed back by noting the current implied rate path would see inflation would be below target in 3 years’ time, in other words saying they won’t hike as much, and confirms our estimates that policy reached peak hawkishness in February. The 100% odds of a 25bsp in May drifted to just above 80% on Friday, and markets will pay close attention to incoming BoE speak, where further push back against rates could be enough to see markets pricing out some of the >5 hikes still priced for 2022. As a result of the clear dovish tilt, we have adjusted our assessment of the bank’s policy stance to NEUTRAL.
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 continues to look too aggressive even after the BoE’s recent push back. This means downside risks for GBP if growth data push lower and/or the BoE continue to push their recent dovish tone.
3. Political Developments
Political uncertainty is usually GBP negative, so the PM’s future remains a risk. If distrust grows question remains on whether a no-confidence vote can happen (if so, short-term downside is likely), and whether he can survive the vote (a win should be GBP positive and a loss GBP negative). The Northern Ireland protocol remains a focus, with previous UK threats to trigger Article 16 and EU threats to terminate the Brexit deal if they do. Markets have rightly ignored this as posturing, but any actual escalation can see sharp GBP downside.
4. CFTC Analysis
CFTC data had a bearish signal last week as all three participant categories saw increased short exposure for Sterling. Price action and positioning has been looking a bit stretched with Asset Managers and Large Spec netshort reaching bottom 20 percentile levels. Our preference remains to look for GBP shorts.
5. The Week Ahead
Retail Sales and S&P Global Flash PMI’s will be the main data highlights for Sterling in the week ahead. The growing fears of stagflation in the UK means the incoming growth data will be very important. Thus, what markets will want to see from the incoming data is whether there are noticeable signs that growth is slowing faster than expected. Markets are already expecting Flash PMIs to slow from prior numbers but are expecting a stronger Retail Sales print. Any bigger-than-expected miss will further exacerbate the slowing growth fears and could see some of the upside bounce in Sterling fade, while a bigger-than-expected beat could see some further recovery for the GBP. In the current stagflation context, we would prefer to trade Sterling on the short side in the event of a miss as opposed to buying it on a beat.
