By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It was your typical turnaround Tuesday in the financial markets. Currencies and equities traded higher across the board at the start of the North American trading session but as the day progressed, the move lost momentum when investors realized that the fundamental story hasn’t changed. Sterling rose as high as 1.3420 before reversing to end the day at 1.3340. The UK Labour Party held a confidence vote and Corbyn lost, which means two leadership contests will be happening simultaneously. The Tories are set to hold theirs in September, which translates into another 2 months of uncertainty for the U.K. before a new Prime Minister is named. David Cameron has made it clear that he has no desire to invoke Article 50 under his watch, so the job of negotiating the E.U. exit will be left to his successor who is likely to begin the process immediately. Unfortunately, two months is a long time to wait in the forex market and the ongoing uncertainty won’t bode well for currencies. Rating agencies are warning of more trouble in the region and companies are freezing hiring and investment. The next support level for GBP/USD is 1.3040, the July and September 1985 low, which we believe will be tested. Brexit deals a major blow to investor, business and consumer confidence and in the coming months, all 3 will refrain from making major investments. The prospect for the U.K. is grim and leading us to believe that all rallies should be viewed as selling opportunities.
Although the U.S. dollar ended the day lower against euro, sterling and other major currencies, it actually staged an impressive intraday recovery. The greenback marched higher versus the yen and drove GBP back to the 1.32 handle. On this relatively quiet day, stronger U.S. data highlighted the brighter outlook for the U.S. economy. First-quarter GDP growth was revised up to 1.1% from 0.8% and consumer confidence rose to an 8-month high. However considering that the survey cutoff was a week before the Brexit vote, we’re sure that if it was taken today, consumers would not be as confident. Personal income and personal spending numbers are scheduled for release Wednesday and unlike Tuesday’s reports, those numbers may be softer considering the slowdown in wage growth and retail sales. According to Fed Fund futures, investors are no longer looking for a rate hike in 2016.
Euro rebounded against the U.S. dollar but its gains were modest compared to other major currencies. A number of ECB officials spoke Tuesday including Mario Draghi and none of them seem to be in a rush to ease monetary policy. While Draghi said the global economy can benefit from alignment of policies, Coeure believes QE is working very well and Nowotny thinks its too early to talk about ECB reaction to Brexit. Taking a step back, markets are “getting more quiet and balanced” as Nowotny described and for this reason, there’s no real urgency to coordinate action with other central banks. The only ones who seem to be nervous are the Japanese, who were apparently holding a meeting Tuesday night to discuss market moves. While we don’t anticipate intervention, strong words could drive USD/JPY to resistance at 103.50. Eurozone confidence numbers are scheduled for release Wednesday along with consumer prices. The market may overlook these reports as they were measured before Brexit, but if we were to consider these indicators now, chances are that sentiment deteriorated and inflation increased due to euro weakness.
For the third day in a row USD/CAD rejected the 100-day SMA. No economic reports were released but oil prices moved higher, capping the currency pair’s rise. The improvement in risk appetite helped the Australian and New Zealand dollars recover but both currencies failed to recapture Monday’s high with the inside candle reflecting persistent weakness. Chinese manufacturing PMIs (manufacturing, non-manufacturing, Caixin) are scheduled for release later this week but what matters most to the comm dollars is risk appetite. They rose Tuesday because risk appetite improved but if stocks resume their rise later this week, AUD, NZD and CAD will fall quickly.