It’s hard to believe that less than a year ago the pound slid to its lowest level against the US dollar since the mid 1980s, with many expecting further losses as concerns about how the UK economy might cope with the twin threats of an extended Covid shutdown, and a messy Brexit, raised expectations that the Bank of England might pull the trigger on negative rates.
Since those multi-year lows, the pound has pretty much gone in one direction, rallying strongly, and closing at its highest level against the dollar in over three years above 1.4000 last week. These gains have come about despite continued concerns about how resilient any recovery is likely to be, given the heavy reliance on services, a fact which was laid bare last week after January retail sales declined 8.2%, the worst fall since April and the first lockdown last year.
Whatever errors the government has made in the last 12 months have been put to one side, with markets choosing to focus on the road ahead, as opposed to the one in the rear-view mirror, with the pound benefiting strongly from optimism about the speed of the vaccination rollout, as well as falling infection rates, which look set to hasten the prospect of an economic reopening. Today Prime Minister Johnson will be laying out the roadmap for an economic reopening, firstly in parliament at 3.30pm and then by way of a 7pm press conference. He is expected to start with the slow reopening of schools on the 8 March in a phased approach, with the finer details expected to be outlined in parliament this afternoon.
With almost a third of the UK population having received their first vaccine, and all over 50s to be offered one by mid-April, the UK is streets ahead of the rest of Europe, who appear to be more concerned with playing politics than inoculating their populations.
This optimism has also given rise to a sharp rise in UK gilt yields, which have gone from lows near 0.17% at the beginning of the year to be trading at 0.7%, last week, with the result that UK banks are now likely to see their profitability improve, having seen their lending margins eviscerated by the flat yield curve. Since the beginning of the year, it’s been notable that bond markets, both in the UK and in the US, are starting to price the risk of higher inflation pressures, as long-term yields move to the upside on both sides of the Atlantic.
Last week US 10-year treasury yields jumped sharply higher to 1.36%, and have continued to do this morning, in a move that suggests that markets are starting to become increasingly concerned about long-term inflation risk, while US 2-year yields remain stubbornly static at around 0.1%. This isn’t altogether surprising given that the US Federal Reserve has insisted that US rates are not going anywhere in the next two years, however there is a risk that in sitting so hard on the front end, as the Fed currently is, the long end might start to get away from it.
US stock markets, as well as European markets to a lesser extent, appear to be getting a little nervous about this, with US stocks finishing lower last week after posting new record highs. Some of the anxiety appears to be around the size of the new stimulus programme of $1.9trn, which could well be agreed this week, with some suggesting that it probably doesn’t need to be as sizeable given how strong some of the recent US economic data has been, with last week’s January retail sales being a case in point, coming in at 5.3%, and their highest level since June last year.
With prices paid data also showing signs of rising sharply, the move higher in yields, not only in the US but also in the UK, appears to be acting as a small headwind. And when combined with sharp rises in energy and commodity prices, there is growing concern that higher prices will not only choke off any post-pandemic recovery, due to higher borrowing costs, but they could also crimp future consumer spending due to higher living costs. For now, stock markets don’t appear to be overly concerned about the recent sharp rise in yields and fall in bond prices, however at some point they might start to be. The big question is where that tipping point is. Is at 1.5% in the US 10-year, or a little bit higher, given that the S&P 500 has a forward dividend yield of 1.53%.
This caution appears to be manifesting itself into this morning’s European open, which looks set to be a lower one, with Asia markets also trading in a similar fashion, with copper prices hitting a nine-year high. The big worry now is that any post-pandemic recovery might lead to rising price pressures in areas that can least afford it.
On the data front, the only item of note is the latest German IFO business climate survey for February, which is expected to remain steady at 89.1.
EUR/USD – failed on several occasions at the 50-day MA and 1.2170 level last week. While below here the bias remains for a move back towards the 1.2070 level. This remains support with a move below 1.2060 reopening the risk of a move towards 1.1980.
GBP/USD – met our 1.4000 target and closed the week there, opening up the prospect for a move towards the 2018 peaks at 1.4380. We can’t rule out the prospect of a dip back to the 1.3820 area, and last week’s lows, but while above the bias remains for a move higher.
EUR/GBP – continues to come under pressure with the 0.8600 area the next key support. A break below the 0.8580 opens up the 2020 lows at 0.8280. Resistance now comes in at the 0.8770 area.
USD/JPY – slipped back from the 106.30 last week, after tripping stops through the 200-day MA. The current pull back needs to hold above the trend line from the January lows currently at the 104.60/70 area. Below that targets the 103.80 area
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