Global Risk Conditions Will Drive Near-Term Pound Vs Euro, Dollar

20.12.22: After Bank of Japan Shock, Global Risk Conditions will Drive Near-Term Sterling and Euro Moves against the Dollar

Overall confidence in the global economy remains very fragile with further unease that the US will slide into recession and trigger a global downturn.

There are important concerns that the central bank policy tightening will cause important damage to the global economy, especially after hawkish Fed and ECB rhetoric.

MUFG commented; “The one two punch from the Fed and ECB has taken the wind out of the sails of the global equity market rebound and has reinforced fears that too much tightening will be delivered thereby increasing the risk of a hard landing for the global economy.”

Overnight, the Bank of Japan (BoJ) announced no change in interest rates which were held at -0.1%. The BoJ maintained a 10-year yield target of 0.0%, but will allow greater flexibility with a 0.00-0.50% band from 0.00-0.25% previously.

Although only a very tentative move, the BoJ move triggered a fresh wave of anxiety and fears that central banks will trigger a global downturn.

Momentum remains a key element and there will be increased concerns that pessimism will dominate into the holiday period.

Confidence will remain fragile, but markets may well have over-reacted with moves exaggerated by a massive liquidation of short yen positions.

In this context, trading volumes will decline into the holiday period, increasing the risk of higher volatility and very choppy trading.

Pound US Dollar Exchange Rate Outlook

There was a similar trading pattern for the Pound to Dollar (GBP/USD) exchange rate on Monday.

There were further concerns surrounding the UK economic outlook with a downbeat CBI survey on the manufacturing sector.

Global risk appetite remained important with a dip in risk conditions undermining GBP/USD support with selling above 1.2200.

The Pound was, however, again able to demonstrate some resilience.

GBP/USD dipped below 1.2100 in Asia on Tuesday after the BoJ move before a tentative recovery to around 1.2150.

Overall confidence in the UK outlook is likely to remain very fragile, especially with fears over a retrenchment in consumer spending after the holiday period. The wave of strikes will also tend to undermine confidence.

There will also be expectations of a dovish Bank of England stance, especially relative to other major central banks. There is, however, still scope for an underlying covering of short positions which will provide some protection with very choppy trading continuing.

Overall risk conditions will remain crucial in the short term with GBP/USD needing a recovery in equities to make any significant headway.

Euro (EUR) Exchange Rates Today

The German IFO business confidence index strengthened to 88.6 for December from a revised 86.4 previously and above consensus forecasts of 87.4. The current conditions component strengthened to 94.4 from 93.2 with an improvement in the expectations index to 83.2 from 80.2

The data maintained evidence of resilience in the German and Euro-Zone economy with some support from lower energy prices.

The Euro, however, was unable to make any headway with support for the currency undermined by weaker risk appetite.

The Euro to Dollar (EUR/USD) exchange rate dipped below 1.0600 as equities lost ground before trading fractionally above this level on Tuesday.

The more hawkish ECB policy stance is likely to protect EUR/USD in the short term with buying on dips.

US Dollar (USD) Exchange Rates Outlook

The dollar overall posted net gains on Monday, primarily due to the impact of weaker risk appetite as equities moved lower and the dollar index edged higher.

The Bank of Japan move triggered fresh volatility with the dollar sold aggressively against the yen while the US currency managed to secure limited net gains against other main currencies.

In particular, there were US gains against risk-sensitive currencies.

The Dollar to Yen (USD/JPY) exchange rate collapsed to 4-month lows at 132.70 before a very tentative recovery with fresh selling to 132.20 in early Europe.

As far as the US economy is concerned, there was fresh weakness in the housing sector.

The data releases will continue to be monitored closely in the short term with the Wall Street performance also likely to be a crucial element.

MUFG added; “The USD could also derive more support heading into year end from the correction lower in global equity markets after they failed to extend their advance so far this month from the October lows.”

Other Currencies

The Bank of Japan decision to allow greater flexibility on the key 10-year bond yield triggered very sharp moves in the yen with a surge on major crosses.

The Pound to yen (GBP/JPY) exchange rate dived to 2-month lows near 161.00 from close to 167.00 immediately ahead of the policy decision.

The Swiss franc was resilient as equities moved lower and the Pound to Swiss franc (GBP/CHF) exchange rate dipped to 1-month lows below 1.1250 before a slight recovery.

Weaker risk appetite also sapped support for the Australian dollar with the Pound to Australian dollar (GBP/AUD) exchange rate touching 9-month highs above 1.8220.

The New Zealand data remained weak with a fresh slide in business confidence.

There was choppy trading in the Pound to New Zealand dollar (GBP/NZD) exchange rate with a net gain to near 1.9200.

The Day Ahead

There are only limited data releases on Tuesday, although the US housing data will be watched closely given fears over a further slide in the housing sector.

Trends in bond and equity markets will be watched closely following another round of sharp moves during the Asian session.

Overall confidence in the global economy will remain a key element during the day as optimists and pessimists look to seize on market moves and any central bank rhetoric.

Position adjustment ahead of the Christmas and new-year period will also have an important influence on all asset classes.