Forex overview. Sterling under pressure as UK yields hit record lows

gbp_news_cmc_forex1Stock markets continued to drift higher yesterday with the German DAX leading the way, following in the footsteps of the FTSE100, FTSE250 and US markets in recovering its poise in the wake of the June Brexit vote, and also climbing back above its previous highs in May, helped in some part by a rise in carmakers share prices on the back of a sharp rise in Chinese auto sales in July.

The S&P500 as well as the Nasdaq 100 have continued to drift higher on a day by day basis with another record high yesterday as the August melt up of the last few days continues unchecked.

The pound has continued its slide, declining for the 5th day in a row after MPC member Ian McCafferty indicated that the Bank of England could ease further by the end of the year. This was despite the fact that he was one of three MPC members to dissent with respect to the implementation of further QE. These comments more than offset some broadly better than expected economic data, as sterling continued to get driven lower.

The nature of Mr McCafferty’s intervention was significant in that he was one of two policymakers to vote for a rate rise over the past few years, though the dovish nature of his comments isn’t exactly consistent with his dissent on extra QE last week.

While the decline in the pound appears to be what the Bank of England wants to see happen in order to cushion any potential setback to the UK economy, the speed of the move isn’t likely to go down to well with our trading partners in Europe, Japan or the US, as it will make their exports much more expensive.

This is likely to be particularly worrisome for the Federal Reserve who may well have to look at delaying any prospective rate rise, despite some decent jobs gains in the last two months, as the weakness in sterling is likely to prompt some form of counter reaction from the European Central Bank and Bank of Japan in the coming months. Jerome Powell a senior Fed officials has already suggested that there is no rush to raise interest rates given the current prevailing conditions.

This expectation is already being reflected in Spanish and Italian 5 year yields which have dropped to record lows in the last few days.

Ultimately the continued decline in bond yields with UK yields now getting pushed ever lower towards the zero bound is forcing capital more than ever into equity markets, and UK stocks in particular are feeling the benefits from that, with the FTSE250 closing in on its highest levels in nearly 12 months.

The continued compression in the UK yield curve is particularly marked with only 5 points now between 2 and 5 year yields. At the end of last year the spread was 69 basis points. The spread compression is even more marked between the 10 and 2 year yield, now at 47.5 basis points compared to 131 at the end of last year.

This perhaps help to explain why the Bank of England had trouble with its attempts to implement its bond buying program yesterday as pension funds and insurance companies refused to give up their bonds, as they struggled to fill their funding gaps. Further drops in yields will only make this problem worse as central bank policy stores up massive problems for pension liabilities in the future.

It could also have the unintended effect of prompting people to save more for their retirement and not less as they realise they will need a bigger overall pot for when they eventually do retire, given pitifully low rates of return.

EURUSD – having found support at the 1.1040 level we’ve rebounded a little, which suggests we remain stuck in the same broad 1.0950/1.1250 range. We need a move beyond 1.1250 to open up a retest of the June highs at 1.1400.

GBPUSD – five days in a row the pound has fallen, dropping below 1.3000 before pulling back from 1.2955, as the previous lows at 1.2800 come back into play. We need to see a recovery back through the 1.3060 area to stabilise and signal a move back towards 1.3200

EURGBP – having pushed back through the 0.8500 level, the previous highs at 0.8610 now come back into view. Support now comes in at the 0.8490 area, with a fall below here arguing for a move back towards 0.8420.

USDJPY – saw a rebound to 102.70 but continues to struggle, and while below the 103.50 area it will continue to struggle. The main support remains back at 100.60 and as long as we stay above here then we could break higher. The risk remains for a move back towards the lows at 98.90 on a break below the July lows at 99.99.

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