Sterling tanks as referendum fears grip the market...

Week Commencing Monday 18th January 2016

Overriding Market Themes

We start this week in good old Blighty, where members of the Conservative government have begun campaigning for Britain to remain in the European Union. It comes as Prime Minister David Cameron continues his push in Brussels for concessions on his four key red lines. This comes as the share of the UK population who say that the UK should leave the bloc rose 6 percent from May to 53 percent, versus 47 percent who prefer to stay. That result does however exclude undecided voters, and when these are included 42 percent will vote to leave, 38 percent to stay, while 20 percent are undecided. This shift in public sentiment has rattled almost every capital market in the UK, including equities and Forex. Sterling continues to feel the pressure, and it is widely expected that if there is a “Yes to leave” vote, Sterling would almost certainly collapse on a scale in line with the Swiss Franc’s decoupling early last year. Ultimately markets hate uncertainty, and until this referendum is settled expect Sterling to perform poorly against almost all of its peers.

Moving to the east now, Chinese exports have defied market expectations are rose by 2.3 percent from a year ago. Markets were expecting to see a 4.1 percent decline in exports, however the ever devaluing Yuan may well have boosted the sector. The figures may help reassure global markets, which have been alarmed by a fall in the value of the yuan and a slide in China’s stock markets since the start of the year. However, some analysts have warned that the yuan would have to fall significantly further to have a major or long lasting impact on exports, and China could risk starting a currency war if it did so. The Chinese government has said its aim is to achieve 6.5 percent growth annually for the next five years, and it may well have little choice but to continue to devalue in order to achieve this goal. Also, slowing global demand, wage rises leading to a less competitive workforce and environmental problems are all causing a drag on Chinese medium to long term growth. One thing is certain however, China continues to remain the one of watch for the rest of the decade.

In oil markets, prices hit their lowest level since 2003 on Monday, as markets braced themselves for additional Iranian exports after the lifting of sanctions against the country over the weekend. The United States and European Union both revoked sanctions on Saturday that had cut Iran's oil exports by about 2 million barrels per day since their pre-sanctions levels in 2011 to a little more than 1 million barrels per day currently. The lifting of sanctions will also unlock more than USD 100 billion in Iranian frozen funds, permitting Iran to finance foreign imports. Tensions continue to run high in the region, with Saudi Arabia and Israel continuing their relatively hostile approaches to Iran. Will this deal change the geo-political tensions of the region? No. Will it bring an extra 80 million Iranian consumers potentially into European and US markets, Definitely!

 

GBP This Week

GBP is unfortunately unlikely to find any relief this week after depreciating nearly 5 percent since the middle of November on a trade-weighted basis. In terms of this week’s data, we expect headline CPI inflation on Tuesday to release around 0.2 percent in December which is slightly above consensus. We also look forward to the November labour market report on Wednesday, is likely to show a moderation in both headline and core average weekly earnings, to 2.2 percent on the year and 1.8 percent on the year respectively. The report should also show that the unemployment rate will remain unchanged at 5.2 percent in November. Finally on the jobs side of things, the December jobless claim release is likely to increase by a modest 1,000 versus a 4,000 estimate, providing a very subtle boost to UK economic sentiment.

The December retail sales figures on Friday may be the main Sterling positive release of the week, with a market forecasted at 0.1 percent however our estimates see the release higher at 0.3 percent.

All the above feeds current speculation that the Bank of England has no choice but to push back its expected rate hike to at least Q4 2016 or even Q1 2017. With this in mind, we expect further GBP weakness versus the USD, with perhaps more muted downside risks when versus the EUR.

USD This Week

We expect the USD to continue its current strengthening trend, particularly versus emerging market currencies, as market volatility continues to fly higher. Concerns about the Chinese government’s handling of the recent stock market turmoil have intensified uncertainty surrounding growth and financial stability. Coupled this with the global slowdown in economic activity, commodity prices declines and excess supply, emerging markets are definitely in the firing line.

Despite doubts about whether the Federal Reserve can increase rates in such an environment, we believe that currencies such as the EUR and GBP will underperform in the medium term. The USD is not immune from these concerns, however the worse the global environment the less likely the Fed will be to raise rates once again. The less likely this is, the less likely other central banks will follow suit.

In terms of data, the most important release of note will be inflation on Wednesday. We expect the core figures for December to show a month on month increase of 0.1 percent (accounting for a 2.1 percent on the year). This is in line with market expectations, so only expect sizable moves should we see a release considerably off the above.

EUR This Week

The ECB January meeting and press conference on Thursday is the most important events for the EUR this week, and while we expect policy to remain unchanged, the doves could push the EUR lower. In the press conference, Mario Draghi is likely to show concern with the tightening in financial conditions that has occurred since its December meeting. He is also due to attend the Davos annual Global Economic Forum, so expect some more interesting questions to be asked then.

In terms of data, we are concentrating on the final headline and core inflation figure on Thursday. We expect non-core to come in around 0.2 percent while core should see a 0.9 percent year on year rise. Finally, Friday’s euro area flash manufacturing should come in around 53.0, services at 54.2 and composite PMIs at 54.1.

 

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