We consider the latest views concerning the pound and US dollar in the wake of the ructions that hit markets following the release of June’s US Employment Situation report and the latest GBP-negative shift in EU polling data.
The pound to dollar exchange rate is seen giving away some of the gains it garnered in the wake of the worse-than-forecast US Employment Situation report issued on Friday the 3rd.
Those who were transferring from sterling into dollars would have witnessed the retail rate available on their bank account to have slipped from around 1.46 on Monday 30th May right down to 1.400-1.41 at the start of the new week.
Independent currency providers are seen offering rates between 1.4277 and 1.4378.
And, many in the market continue to expect the pound to dollar exchange rate to decline over the course of the next two weeks, even with the US dollar facing its own problems.
The pound is heading lower courtesy of weekend polling data that confirms a swing back towards the Leave vote in the EU referendum with the latest Opinium/Observer poll showing Leave stand at 43% while Remain stand at 40%. This is an about-turn on the previous 44% remain and 40% Leave that was reported two weeks ago.
"Brexit concerns continue to be the talk of the town for GBP traders, and the pair sold off from the top of the sideways medium-term last week. I would advise a great deal of caution heading into the Brexit vote. While my base case is that the UK does stay in the EU, there is a serious risk of a outlier event (think SNB removing the floor but not as big). The vote itself is not until 23rd of June, so it’s fine if you are a short-term/swing trader for now, but long term traders should already be planning ahead how they want their portfolio to look heading into the event," says Sean Lee, a professional trader who heads up the Forextell service.
US Dollar on the Defensive
The US Employment Situation report appears to have been something of a game-changer for the US dollar - the USD gained 3.4% in May but then gave back 1.5% in a few hours on Friday following the release of data that showed the US only added 38K jobs to the workforce in May.
Fed Fund futures are now only pricing in a 30% chance of an interest rate rise at the US Federal Reserve in July down from more than 50% pre-NFP.
Fed funds futures have used the weak employment report as an opportunity to push the first rate hike all the way out from July to December. With the prospect of higher returns coming out of the US turning more remote, global investors have sold dollars.
Only when fund futures are bought forward again will we likely see the USD start clawing back lost ground.
This cautious Fed is simply not going to raise rates when the latest available number shows lacklustre employment gains.
The outcome helped the pound bounce higher against the US dollar - nevertheless, sterling still underperformed the dollar over the course of the week and was the only major currency to lose ground against the Greenback.
“GBP is likely to become exclusively poll-driven in coming weeks, if it isn’t already,” says Richard Franulovich at Westpac Institutional Bank, “our best guess is that the Brexit/uncertainty premium puts GBP fair value nearer 1.40-1.42 where it’s worth a buy.”
Westpac’s base case is for a commanding “Bremain” win, in similar vein to the UK general election and the Scottish independence votes, where polls proved to badly understate support for the “status quo”.
“Dips into the low 1.40s are to be bought but only closer to June 23,” says Franulovich.
Has the Dollar Been Unfairly Punished?
The dollar is up against the euro, pound and a number of other majors at the head of the new week with some in the market judging the previous week's sell-off as being something of an over-reaction.
Harm Bandholz, US Economist with UniCredit Bank, says he believes markets are being too negative on the USD.
“While I do not want to dismiss the May employment report, I do take it with a large pinch of salt, as other labor market indicators have not shown any signs of weakness to date, while the economy has recovered nicely after taking a breather at the turn of the year,” says Bandholz.
So either the May slowdown in payrolls will be revised away or we see a rebound in the following months.
With upcoming data releases corroborating the Fed’s view that the economic recovery remains on track, and the Brexit risk off the table, “we expect two rate hikes for the remainder of the year, and thus remain more bullish than financial markets,” says Bandholz.
Interestingly Bandholz has accused the Fed of bamboozling markets by putting too much emphasis on the volatility of short-term indicators and financial market fluctuations, “thus pursuing a zigzag path that has confused not only market participants but sometimes FOMC members themselves.”
That said, Bandholz thinks that markets tend to be too cautious when it comes to the interest rate outlook.
The implication then is that the dollar has been potentially oversold.
Currently, the Fed funds futures have priced in only a single rate hike for 2016 (and that barely), followed by another one in 2017 (barely) and another one in 2018.
“A total of less than three full rate hikes over the next 2½ years just doesn’t look right,” argues Bandholz.
UniCredit believe the Fed is now basically meeting both of its mandates:
- The unemployment rate fell to 4.7% in May, the lowest since late 2007, and measures of underlying inflation rates average around 2%.
- Wage gains have picked up, with average hourly earnings rising 2.5% yoy.
- The most closely followed labor costs measures, including average hourly earnings or the Employment Cost Index, are biased downward by demographic shifts, i.e. the retiring of higher-paid baby boomers
“I continue to expect the Fed to raise rates two times in 2016, followed by three more hikes in 2017 – and more in 2018,” says Bandholz.