Sterling drops below 1.2800

6 July, 2016

The pound has continued to come under pressure in the past couple of days sinking to new 31 year lows around the 1.2800 level against the US dollar and multi-year lows against the yen and the euro as well. The suspension of commercial property fund redemptions by a number of big players has precipitated a broader sell off in the UK property sector including house builders and other asset managers.

Combined with a warning that some Brexit effects were already starting to crystallise and this week’s slowdown in recent economic data we’ve seen a bit of a domino effect in locally exposed sterling assets, as well as risky assets generally across the world.

While some have speculated that some “Leave” voters may have undergone some form of buyer’s remorse in the wake of the volatility of the UK Brexit vote outcome, it would seem that the same could also be said of the investors who took part in last week’s stock market rebound in the aftermath of the said vote.

We’ve seen strong selling interest across the board this week, particularly in main European markets as concerns about future growth prospects as well as the resilience of the banking sector gives increasing cause for concern, as investors focus their attention on the weak spots of the European economy.

Bank of England governor Mark Carney may well be the only adult in the room when it comes to managing the UK economy at the moment, as speculation rises about the prospect of a UK rate cut next week, there is little he can do to stop the contagion seeping into Europe’s sclerotic banking system.

At the beginning of this year European banks were already facing a host of problems, including falling profits, a slowing global economy and negative rates reducing their ability to boost their profitability, at a time when a lot of them were being encouraged to boost lending to the wider economy as well as improve their capital buffers. Quite simply it isn’t possible to do all of them at the same time.

As events have moved on since then none of these facts have changed and have in fact worsened with Swiss yields now negative out to 50 years, and German and Japanese yields negative out to 15 years, with the biggest banks in Switzerland and Germany trading at all-time lows.

Throw in solvency concerns over the fiscal health of Italian banks and a huge amount of non-performing loans, and you have a poisonous cocktail that has the potential to bring Europe’s banking system to its knees, and for now it would seem that policymakers have no idea as to what can be done to deal with it.

With the latest FOMC minutes due out later today attention will be fixed on the narrative behind the decision to keep rates on hold. We do know that some Fed policymakers were somewhat dismissive of the potential for the Brexit vote to impact on the US economy, however events have moved on since then and policymakers at the time will probably have been more concerned about the abrupt slowdown in the recent jobs market data that surprised the markets less than two weeks before the meeting.

Just over a month ago markets were pricing a 30% probability of a rate rise this month, and a 45% probability of a rate increase in September, and while last month’s payrolls report diminished that slightly in the days after, the rebound in the US dollar since then as well as the outcome of last month’s Brexit vote has pretty much wiped that possibility out to zero until 2017.

This would suggest that tonight’s minutes aren’t likely to be that relevant, though they might shed further light on the discussion that took place over the St. Louis Fed’s James Bullard, and the mystery of the missing long term dot, and the thinking behind his transformation from an Uber hawk to Uber dove, and arguing that only one more hike would be needed between now and 2018.

EURUSD – the euro continues to struggle with the bias remaining towards a move towards the March lows at 1.0825. To stabilise we need to see a move back above the 1.1250 area.

GBPUSD – this continues to be the big mover breaking below 1.3120 and opening up a move below the 1.3000 level. Having hit the 1.2800 level we could well head towards 1.2500, with a recovery back through the 1.3120 level needed to stabilise.

EURGBP – having broken through the 0.8410 area we look set for a retest of the 0.8706 area, 61.8% retracement of the big down move from 0.9805/0.6535. A move back below the 0.8400 area would delay this outcome.

USDJPY – while below the 103.50 area the risk remains for a return to the 100 level as well as the previous lows at 98.95. A move below 100.00 is likely to prompt the risk of further losses and possible BoJ intervention concerns.

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