FX market outlook

FX market outlook

Posted on Wednesday, December 12 2018 at 9:43 am GMT+0000

Pound under pressure as Tories trigger leadership contest

  • Sterling near 20-month lows as Conservative lawmakers trigger no-confidence vote in Theresa May; ballot to be held today
  • Risk appetite recovers as Trump and China stoke hopes for a deal
  • Euro remains on the back foot ahead of tomorrow’s ECB meeting
  • US inflation data on tap

Sterling crumbles as Tories trigger leadership challenge

The British pound sank to a fresh 20-month low versus the dollar on Tuesday, following reports that “rebels” within Theresa May’s Conservative party nearly have the numbers required to trigger a leadership challenge against the PM. Earlier today, it was confirmed that the no-confidence vote has officially been triggered – the ballot will be held at around 1800 GMT. The timing was critical; it came as PM May was visiting European capitals in an attempt to squeeze out some last-minute assurances on the Irish backstop.

Hence, uncertainty deepens further, as any concessions granted by the EU may not mean much if May is replaced by someone who doesn’t share her Brexit views – a Boris Johnson for instance. As for the pound, its near-term direction may hinge on whether May can survive this leadership struggle or not. If she stays, the currency could soar as attention turns back to what kind of reassurances the EU will grant, whereas a potential defeat for May could see sterling touch new lows as political uncertainty peaks and the risk of a disorderly Brexit is amplified.

Risk sentiment recovers as China and Trump stoke optimism

It was volatile session for risky assets, and in particular stocks, on Tuesday. Sentiment was initially boosted by reports China is planning to cut tariffs on American cars, which was seen as a gesture of good faith in the talks. That didn’t last though, and US indices reversed to close slightly lower overall, after Trump threatened to shut down the government if Democrats don’t side with him on border security.

Later, during the Asian session on Wednesday, risk appetite recovered after Trump noted he would definitely intervene in the Huawei case, if that would help secure a better trade deal with China. Asian stocks were a sea of green, while futures tracking the likes of the S&P 500 are pointing to a higher open today. Although both sides have been trying to stoke optimism lately, playing up the prospect that these talks will bear fruit, recent price action suggests investors remain skeptical. The “game changer” would be any signs China is willing to make some concessions on the burning issues of forced technology transfer and intellectual property protection, which aren’t evident yet.

Euro unable to sustain gains amid Brexit woes, French uncertainties

The common European currency remains broadly on the back foot, as the Brexit drama continues to dim the prospects for the Eurozone as well. Another contributing factor may be that markets appear increasingly nervous the EU may be forced to issue a negative reply to Macron’s expansionary budget plans, or risk Italy’s wrath. Italian politicians made it clear yesterday their nation will not stand for any preferential treatment of France on fiscal matters, adding yet another layer of uncertainty to European politics. In the more immediate-term, all eyes remain on the ECB policy meeting tomorrow.

US inflation data on the agenda today

The highlight on the economic calendar today will be the US CPI figures for November, due at 1330 GMT. Forecasts are mixed, with the headline CPI rate expected to dip following the recent plunge in energy prices, but the core rate anticipated to tick higher. Given recent speculation that the Fed will pause its tightening cycle in 2019, these figures may be crucial in shaping market expectations ahead of next week’s policy meeting and thereby, in determining the dollar’s near-term direction.

Note that the dollar has held up quite well in recent sessions, even as investors continued to price out Fed rate-hike expectations, to the point where Fed funds futures now suggest a mere 55% for just one 25bps hike in the entire of 2019. This demonstrates the US currency can currently stay in demand even without support from monetary policy expectations, not least due to a lack of attractive alternatives in the G10 FX space.