Carney and BoE Send Pound Lower with Dovish QIR
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Carney and BoE Send Pound Lower with Dovish QIR

While it wasn’t the “buy everything this isn’t nailed down” rally from  Monday, the S&P managed to edge  out another record close yesterday, posting a modest 0.04% increase  but  holding below the psychological 1,900 level.    Soft retail sales in the US kept a lid on any exuberant investor optimism,  with a decline  in import and export prices during the month of April shifting investors expectations that  Thursday’s  CPI reading  will likely  remain  sluggish.   Despite the less than enthusiastic retail sales numbers, the  rebound in the DXY continued as the EUR slumped further, with the  USD-linked index rallying to levels  not seen since early April.

After a relatively uneventful overnight session in Asian  markets that saw the  major equity indices edge slightly lower,  European markets got busy with a number of event risks that traders were keenly focused on.    Employment statistics for the UK economy were released earlier this morning, with the number of people claiming unemployment benefits over the month of April falling by just over 25k, a  modest disappointment given that analysts had expected a similar performance compared to March when we saw a decrease of 30k people.   The unemployment rate was also released at the same time and as expected dropped from 6.9% to 6.8% in March, however earnings over  a three  month period compared to the same time frame slide to only a 1.7% increase versus expectations of a 2.1% rise, highlighting some of the issues with excess slack in the  labour market.   While the unemployment is now well  situated below  7%, the weak returns on labour are likely to help the BoE justify keeping rates on  hold for a longer period of time.

Shortly after the employment situation, the BoE’s Quarterly Inflation Report was released, and was a little more on the dovish side than markets had anticipated.   The key takeaway from the report was that more slack in the economy  can be absorbed  before rates begin to rise, and while Carney did acknowledge the British economy is moving closer to the point of needing tighter policy, the BoE is prepared to wait until 2015 before raising rates.   In response to the potential for an overheating housing market, Carney  opted to state that the first line of defense against a housing bubble was to tweak  mortgage lending rather than  raising rates,  with the ability to amend macro-prudential policy measures so as  to keep the  affects limited to the housing market itself.   The  release of the QIR  and the lack of urgency to tighten policy had participants re-pricing expectations of the  first rate hike from February 2015 to March 2015, and subsequently causing the Sterling to come under selling pressure; GBPUSD fell below the 1.68 level, but is starting to find a base in the high-1.67s.

The speculation as to what  the ECB will do at their next policy meeting continues to run rampant, with  the central bank economists Mersch and Praet outlining a number of policy measures that could  be introduced  at the June meeting.   There was nothing new in terms of  what Mersch and Praet outlined (rate cuts,  new LTRO, ABS purchases), yet the  markets have keyed in on what was not said, as the economists stopped short of reinforcing the expectation for  the introduction of a full scale QE program.    Reports released this morning that have cited sources familiar with the matter seem to indicate the ECB  has settled on at least cutting rates in June,  with members leaning towards also introducing either a targeted LTRO or an ABS purchase program comprised of SME loans.   The failure to stoke the fire in regards to a large-scale bond purchase program has helped the EUR  find some support against the dollar this morning, with EURUSD  garnering a bid ton in the low-1.37s.

Heading into the North American open, S&P futures are looking content to ease back from their record close, with a moderate weight t  to the tape that is setting up for a negative start to the day.    Commodities on the other  hand are broadly higher, with the lack of de-escalation in Ukraine pushing investors to increase exposure to hard assets.    A  relatively dovish BoE and potential for more accommodation from the ECB has gold  well above the $1,300 level, while front-month WTI surpasses $102/barrel, and copper jumps  above $316/lb.   USDCAD is struggling  with the 1.09 pivot again, it’s third consecutive session being pinned to the round number.   While commodity prices and demand for commodity-linked currencies are  lending support to the Loonie,  US-CDN yields spreads continue to rise and thus warn of upside risk in USDCAD.

With a rather quiet day on the docket in terms of economic releases for North America, things pick-up  tomorrow  with manufacturing sales out of Canada and  consumer prices  in the US.   Considering the Federal Reserve  in on a well-defined tapering schedule with little  in the way  that could derail the wind-up of its asset purchase program by the  fall,  market participants have now shifted their focus to  how consumer price levels will affect  the time-line of when the Fed will first start to raise short-term rates.   Should inflation remain well contained below the 2% rate, this  will allow the Fed a greater amount of breathing room and the flexibility to keep rates low in the hopes of making sure the recovery  doesn’t falter, while the prospect of inflation  potentially pushing towards the upper end of the Fed’s target will increase speculation the Fed will have to look at raising rates by the middle of 2015.

The median analyst  estimate is forecasting  that the  headline CPI reading for April  will reach the mid-point of  the Fed’s  band at 2.0%, up from the 1.5% that was registered in March.   While on the face of things a 2% print suggests a  subdued inflationary  environment will not be an issue in America,  the headline reading is discounted somewhat considering  the  core reading is expected to remain flat at 1.7%, with some of the higher prices in  the more volatile items  being transitory in nature.   A  hotter than expected reading north of the 2.0% mark would generate buying demand for the USD as traders  shift their  view forward on when the Fed might be looking to raise rates, with  a sub-2.0% reading have an opposing effect on the USD as  bond demand increases.   In terms of what could be expected  tomorrow,  soft retail sales and a decline in import/export prices  were somewhat mitigated by the fact that the PPI index  for  April increased by more than forecast coming in with a 0.6%  increase, however we feel there is a good possibility of a downside surprise with the release as competition in the retail space will likely keep producers from passing along those increased costs to their end users, and thus the potential for  the USD to elicit an offer tone from traders.

Further reading:

EUR/USD May 14 – Euro Shrugs off Weak Inflation, Manufacturing Numbers

UK Inflation Report will determine the fate of forward guidance


Scott Smith

Scott Smith

Scott Smith is a Senior Corporate Foreign Exchange Trader with Cambridge Mercantile Group and has a diverse background in the foreign exchange industry, with previous experience in both credit and trading related functions. Scott holds a Bachelor of Commerce degree from the University of Victoria, has completed all three levels of the Chartered Financial Analyst designation, and is currently working towards the Derivative Market Specialist certification offered through the Canadian Securities Institute. Cambridge Mercantile Group.