August 02, 2024

“Yesterday brought a lot of movement once again, as a Bank of England cut dented the pound and worsening US data led to a sell-off in equities and safe haven flows to the yen and the franc. These softer signals make this afternoon’s non-farm payrolls release highly consequential for the Federal Reserve.”

Sam Cornford – Head of Trading

Main Headlines

The US government completed the biggest East-West prisoner swap since the Cold War yesterday, as Wall Street Journal journalist Evan Gershkovich and ex-marine Paul Whelan arrived in the US last night. The deal, involving 24 prisoners, was described by President Biden as ‘a feat of diplomacy and friendship’

UK Prime Minister Keir Starmer hit out at social media companies yesterday and warned them to abide by laws on the online incitement of violence, in the wake of violent riots across the UK spurred on by online misinformation following events in Southport earlier this week.

GBP

The FX markets largely pre-empted the Bank of England’s first rate cut yesterday and sterling fell up to 0.8% in the hours before the decision was announced. It then attempted a rebound but eventually settled 1% lower. The decision to cut was a ‘finely balanced’ one at a 5-4 vote, and the main message was that there is still more work to be done in getting the medium-term drivers of inflation towards a state compatible with maintaining 2%. Interestingly, the justification policymakers used was not that anything had materially changed in the data since the June meeting, but that the ‘accumulation of evidence’ – and presumably the passage of time – had now given them enough confidence in forecasts for a downtrend in services inflation that they could adjust slightly the level of restrictiveness. The BoE tends to shy away from pre-commitments and left forward guidance light, but the inflation projections again signalled that the market-implied rate path would be sufficient to bring inflation to the target. That currently pencils in a quarterly pace of rate cuts.

EUR

With no noteworthy domestic catalysts yesterday, the euro was dragged lower by falling yields as investors looked to the start of the Bank of England’s rate cut cycle. The final manufacturing PMI yesterday morning was little changed from the first estimate at 45.8, as a downward revision for the Spanish economy offset some marginal improvements in Germany and Italy. The calendar is similarly light today, and EUR/USD will look to rebound if US non-farms surprise to the downside. EUR/CHF is a pair worth keeping an eye on – safe haven flows and carry trade unwinds have strengthened the franc by 3.5% over the past two weeks and it’s now at its highest level since February. EUR/CHF was up almost 7% year-to-date at the end of May, and that figure is now 1.4%.

USD

Falling yields in Europe lent some support to the US dollar yesterday. It then held steady despite some soft macroeconomic data, including a 249K jobless claims print – the highest in over a year – and a disappointing ISM manufacturing PMI that fell further into contraction at 46.8. For a long time, bad news has been good news for investor risk appetite, because a slowing US economy meant that the Fed could kickstart rate cuts and lower borrowing costs. This relationship has begun to reverse, however, and concerns that the Fed may already be too late to save the economy mean that the result yesterday was a selloff in equities and a safe-haven boost for the dollar, which counteracted the extra rate cuts priced in. Rate cuts in a slowly cooling economy are great for risk; rate cuts to save a more severe slowdown would be a worst scenario. Markets currently priced a near 30% chance that the Fed delivers a jumbo 50bps cut in September for fears of a more rapid deterioration in the labour market, although many have also argued that this pricing is excessive. Nevertheless, it puts a lot of weight on this afternoon’s non-farm payrolls report, which is expected at around 175K.

Markets

Deepening concerns about a more sinister downturn in the US economy sparked a broad market selloff yesterday and ramped up volatility to a more than three-month high. The Nasdaq slipped 2.3%, the S&P 500 fell by 1.4%, and the European Stoxx 600 fell by 0.8%. The spillover into Asia was particularly pronounced, with Japan’s Nikkei falling over 5% both on risk aversion and on a stronger yen, in what was its worst day in over four years.

Main Economic Events (All Times CET)

3:30am: Australian PPI
8:30am: Swiss CPI
1:15pm: BoE’s Pill speaks
1:30pm: US Non-Farm Payrolls

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