CAPITALDIGEST MARKET REVIEW, 13/6/2023

STERLING SLIPS AFTER SURVEY DATA SHOWS HOUSE BUILDING SLUMP The pound slipped on Tuesday as data showed that British house building wilted in May and the dollar found a footing. Sterling was last down 0.18% at $1.241. The euro was flat against the pound at 86.18 pence. The survey data showed house building in Britain fell at its fastest pace since May 2020 last month as construction companies struggled with rising interest rates. The headline purchasing managers’ index (PMI) survey score for the construction sector came in at 51.6 in May, above the 50 mark which signals growth and up from 51.1 in April. Yet the headline concealed divergence within the construction sector, with commercial and civil engineering activity rising but house building suffering. Chris Turner, head of markets at ING, said in a research note that Britain faced a “mortgage time bomb”, with more than 600,000 mortgage holders due to refinance at higher rates in the next six months. Turner said this could lead to the Bank of England (BoE) raising interest rates by less than markets expect. Traders currently envisage rates rising to around 5.4% later this year, from 4.5% currently. The pound rose to a one-year high of $1.268 in mid-May as inflationary pressures remained strong – making more BoE rate hikes likely – and the outlook for the British economy has brightened somewhat. It has since slipped as the dollar has found favour among investors due in part to fears about the now-resolved U.S. debt ceiling standoff and in part because of strong U.S. labour market data. The dollar index – which measures the greenback against six peers – wasup 0.15% at 104.15. DOLLAR EDGES UP AGAINST YEN AS INVESTORS WAIT ON INFLATION DATA, FED The dollar edged higher against the yen on Wednesday as investors awaited U.S. inflation data for May and the Fed’s interest rate decision next week, while the Canadian dollar jumped after the Bank of Canada hiked rates. The U.S. central bank is expected to hold rates steady next Wednesday as it evaluates the impact of recent rate increases, though Fed fund futures traders are pricing for an additional rate hike in July. Consumer inflation data on Tuesday is expected to show that prices rose by 0.30% in May. “We expect a fair degree of consolidation ahead of the Fed decision next week,” said Bipan Rai, North American head of FX strategy at CIBC Capital Markets in Toronto. “That CPI number’s going to be critical for the Fed decision as well. To me it makes sense that we don’t see large bets placed either way at this point.” The dollar gained 0.31% to 140.10 yen, while the euro rose 0.11% against the U.S. currency to $1.0703. The dollar index was little changed on the day at 104.07. Data on Wednesday showed that the U.S. trade deficit widened by the most in eight years in April as imports of goods rebounded while exports of energy products declined. Traders have also priced out most expectations that the Fed will cut rates this year as inflation remains above target.”There is persistence and resilience in inflation in the U.S., but also in much of the G10, as well, meaning that central banks are likely to be cautious,” said Rabobank chief strategist Jane Foley. The Canadian dollar strengthened after the Bank of Canada hiked its overnight benchmark rate to 4.75%, the highest level in 22 years. The U.S. dollar was last down 0.23% against the loonie at C$1.3371. Although the rate hikes by foreign central banks could put pressure on the greenback, the prospect of an additional Fed rate increase in July is likely to limit losses. STERLING STEADY AS UK HOUSE PRICES POST FIRST YEARLY DROP SINCE 2012 -Sterling held steady on Wednesday after data showed the first annual drop in UK house prices in more than a decade, and traders focused on sticky inflation and the outlook for Bank of England monetary policy.At 0821 GMT, the pound was flat against the dollar GBP=D3 at $1.242, having earlier dropped by as much as 0.2% after the house price data. It was also flat against the euro at 86.07 pence EURGBP=. The pound has slipped from an 11-month high of $1.26790 touched on May 10. British houses prices fell on an annual basis in May for the first time in 11 years, mortgage lender Halifax said on Wednesday, as an increase in mortgage rates from the country’s largest provider comes into effect. “The bigger impact house prices have is in the equity markets, as they are important for housebuilders, and it is no surprise that we are seeing the likes of Persimmon and Redrow all trading lower this morning,” Stuart Cole, chief macro economist at Equiti Capital, said. He added inflation and the rate outlook is a more important driver for now. On May 26, data showed British inflation fell in April, but by less than expected. It remains above the rate of price growth in the United States and most of Europe. The data raised bets that the BoE will have to keep hiking interest rates. The UK central bank will next convene on June 22, with traders betting on an 88% chance of a 25-basis-point rate rise. IRPR. The BoE has raised rates 12 times since late 2021 to 4.5% from just 0.1% in to try to calm inflation. Britain’s next consumer price index print is due on June 21, while labour market data is due on June 13, with both keenly anticipated for a steer on the BoE’s next likely move. Another point of focus for Cole is whether the BoE will end up hiking to the extent that it drives the economy into recession. “That risk appears to have diminished of late, but if core CPI continues to perform strongly then I think they will start to resurface,” he said. DOLLAR PEELS OFF TWO-WEEK LOWS AHEAD OF CENTRAL BANK DELUGE The dollar bounced off two-week lows on Friday, shrugging off some of the weakness that has set in this month as expectations have grown that the Federal Reserve may not raise interest rates again for some time.Next week is packed with key monetary policy meetings, including those of the Federal Reserve, the European Central Bank and the Bank of Japan. Meanwhile, data on Thursday that showed a rise in the number of Americans filing new claims for unemployment benefits surged to the highest in over 1-1/2 years last week pushed the dollar index down 0.8% – its largest one-day fall since the depths of the regional banking crisis in March. The index, which measures the U.S. currency against six others, is down 0.6% for the week, set for its biggest weekly fall also since mid-March when fears about the health of the banking sector roiled markets. It was last up 0.2% on the day. “This jump put jobless claims close to a two-year high and has been read by markets as a clear sign of coming weakness in the U.S. economy and a more-hesitant-to-hike Fed,” CaxtonFX strategist David Stritch said. “The question now becomes, is this data isolated and the market simply read too much into it, or is it the first red flag that the U.S. economy may be weaker than first expected?” Money markets show traders are placing just a one-in-four chance of a 25-bp rate hike next week by the Fed, which would bring U.S. rates to 5.50%. 0#FEDWATCH “Before the meetings that we had this week I would have said I was expecting the status quo, now I’m not excluding something surprising, because a central bank like Canada, that had clearly telegraphed it was on hold, raised rates and said it was concerned about inflation,” said Chester Ntonifor, FX strategist at investment provider BCA. The Bank of Canada and the Reserve Bank of Australia both jolted markets earlier this week by raising interest rates to tackle stubborn inflation, which has raised expectations for other central banks to stay tough on price pressures. The ECB meets on Thursday and is widely expected to raise eurozone rates by 25 bps to 3.50%, given core inflation is still rising, even though headline inflation has softened. STERLING LOGS A SECOND WEEK OF GAINS AS RATE OUTLOOK HEATS UP The pound headed for a second week of gains on Friday, boosted by the prospect of UK interest rates catching up with U.S. rates, as the Bank of England fights to bring down the highest inflation across leading economies. Sterling is on track for a weekly rise of 0.7%, on the heels of last week’s 0.8% gain. The pound was last down 0.1% against the dollar at $1.2541 and flat against the euro at 85.89 pence. Earlier this week the Organisation for Economic Co-Operation and Development said headline inflation in Britain will be at 6.9% by the end of this year, compared with an OECD average of 6.6%. This would leave UK inflation above that of Turkey and Argentina. Inflation peaked at a four-decade high of 11.% in October and has since retreated to 8.7%, but this is still over four times the BoE’s target of 2%. As other central banks reach the end of their respective monetary policy cycles, the expectation is the BoE still has further to go in raising interest rates, which could tilt the economy into a recession that it has so far avoided. While this might be unwelcome news for bond or equity investors, it is theoretically supportive of the pound. “Sticky inflation raises the prospect of more interest rate hikes from the BoE, in contrast to the Federal Reserve, which is widely expected to pause interest rate hikes in June with another possible rate hike in July,” City Index strategist Fiona Cincotta said. Money markets are currently pricing in a peak of 5.5% for UK rates, up from 4.5% right now. U.S. rates, by contrast, are at 5.25%, which traders roughly believe is at, or close to, the peak. Another 100 basis points in rises from the BoE would erode the appeal of the dollar among yield-hungry investors. Against the euro, however, the picture is less bullish for the pound, according to ING strategists. “We remain of the view that EUR/GBP will increasingly struggle to find more bearish momentum now that markets are already pricing in 100 bps of Bank of England tightening and the pair is already in undervaluation territory,” Francesco Pesole wrote in a daily note. The euro has fallen by around 4.5% against the pound in the last four months and is trading around its lowest since mid-December.