GBP better bid despite rising uncertainty
The pound sterling edged slightly higher against the greenback on Tuesday as investors tried to switch their focus to the upcoming general election from the weekend’s terror attack. The Conservatives, ahead of the Labour party by a massive 20 points six weeks ago, now have 42% of voting intention or a four point lead over Labour.
GBP/USD continued to gather momentum as it rose 0.15% to 1.2925. The UK may be heading for a bumpy ride as the Conservatives may not get the expected support from the people. Investors anticipated that a solid Tory lead will help the UK get a better deal from the European Union. However, the eroding Tory support runs counter to these expectations and raises the likelihood of a GBP sell-off. Nevertheless, Theresa May’s party will surely remain in office and will even increase their working majority in the House of Commons. Therefore, we believe it is too early to ring the alarm bells yet.
Heavy risk weeks send JPY higher
Risk sentiment remains negative with significant rotation into safe haven trade such as JPY, CHF and gold. Yet as with recent shift in sentiment this move feels like fear of heights rather than any structural change.
Markets are pointing to a build-up of risks rather than a single event for example the UK elections, geopolitical events, slow growth in US, ECB meeting and Comey Testimony. The escalations in tensions in the Middle East have now also halted diplomatic communication between Qatar and its neighbours. That situation has damaged oil prices as markets question the unity of OPEC.
In FX markets, falling US front end yields have killed USDJPY bullish momentum. Correlation between US/JP yields and USDJPY remains insanely tight.
While JPY yield remained pinned, the pushing out of Fed rate hikes has narrowed the interest rate differential. While risk aversion headlines sound nice USDJPY is reliant on performance of the US economic fundamentals and the effect on fed interest policy. Given the US schedule and general Trump-driven uncertainty (and action packed Thursday schedule), USDJPY clearing 109.65 will target 108.10/15 support.
Perhaps the primary worry to our theory that risk aversion is transitory, and buy on risk dips, is the ECB meeting on Thursday. We anticipated that Draghi will retain his dovish tone until September, yet given the strong EU economic data the probability that he hints of reduction of emergence measures has increased. Even the slightest ECB signal would have profound effects on asset prices that have relied for 10 years on central bank excessive support.
Oil may hit $44 a barrel with prices under strong downside pressures
This last weekend was intense in the Middle East. Indeed, Saudi Arabia and other OPEC countries (Egypt, Bahrain and United Arab Emirates) have all cut diplomatic relations with Qatar due to the nature of its relation with terrorism.
The growing geopolitical uncertainties have as a result sent the oil prices lower. There is the growing fear that with this major political issue, Qatar may not comply with the extended production cut which OPEC agreed for nine more months.
A barrel of crude is now trading below $48 and has lost around 8% since May 25. We now monitor the risk of military escalations between the two major OPEC members which seems at the moment very unlikely but would put larger downwards pressures on oil.
Nonetheless, we believe for the time being this diplomatic incident is compromising the OPEC deal, despite Qatar being a very small oil producer and one of the smallest amongst OPEC.
At the same time, it is important to notice that US crude production has increased by 10% in the last year and this is adding up to put stronger downside pressures on oil. We target $44 a barrel within the next few weeks.
