Markets Weekly podcast – 6 April 2023

Julien Lafargue (JL): Welcome to a new edition of Barclays Private Bank Market Weekly podcast. My name is Julien Lafargue, Chief Market Strategist at Barclays Private Bank, and I will be your host again today.

As usual, we will go through the events from last week and the implications going forward before moving on to our guest segment. And, today, I’m very pleased to be joined by Bhaskar Gupta, who heads our FX Distribution here in the UK, to discuss FX markets.

But before we talk to Bhaskar, let me take a look back at what happened last week, and, for once, it was a relatively uneventful week, which I think we won’t complain too much about. 

There was very little in terms of economic earnings as well as central banks. A few things to note, though, mostly on the inflation front. There were two key datapoints that investors were waiting for. 

The first one came from the eurozone. The region published their headline inflation for March, and that was a positive surprise in the sense that headline inflation declined to 6.9% from 8.5% in February, so a sizeable decline in headline inflation. However, and that’s the important bit, the core measure posted a fresh all-time high at 5.7% year-over-year. That’s not a huge jump from the previous reading at 5.6%, but it shows that the core component of inflation in the eurozone is much stickier than people may have expected. Of course, the sharp drop in headline inflation was mainly the result of the negative base effect from energy prices, but, outside of that, there was very little good news for investors.

I think the most striking example of what’s at play here comes from Spain. Spain saw its headline inflation drop to 3.1% in March which, you know, puts it very close to what the ECB would consider as acceptable. The month prior to that, Spain’s inflation was at 6%, so it nearly halved in the space of a month, but that was at the headline level. Core inflation in Spain remains very high at 7.5%, so this is the dilemma that central banks, and the ECB in particular, will have to address.

In the US, we also had inflation data, the PCE inflation number, which is the Fed’s preferred measure of inflation. Here, again, a positive surprise, although not to the same extent as what we’ve seen in Europe. Core PCE prices came in at 5% year-over-year. That was slightly below what was expected, 5.1%, on a monthly basis, which is what people tend to look at most to try and understand what’s the trend, when it comes to the PCE. The price index rose 0.3% month-on-month. That was in line with the consensus, but still a downshift from the January number, which was 0.6%. Remember that the PCE is a bit of a lagging indicator, so we just got the February data, although we’re in April today.

Aside from that, a very quiet week. That, nonetheless, didn’t prevent a strong risk-on market. US equities were higher for the week. The S&P 500 and the Nasdaq Composite actually logged their third-straight weekly gain. European equities also closed higher, recovering almost all losses sustained in early March. Treasuries, meanwhile, were weaker, with the curve flattening some more. 

The last piece of news that we got was the decision by the OPEC members, or at least some of them, eight of them to be precise, to cut production by 1.1 million barrels per day, starting from May. Leading the charge, obviously, is Saudi Arabia with 500,000 barrels of supply to be cut. Russia is also confirming that the 500,000 barrels per day of production that they were thinking about removing from the market, starting in March, will actually extend through the end of the year. 

So, altogether, we’re talking about roughly 1.6 million barrels per day that will be taken off the market. That, obviously, prompted the initial positive reaction on the oil price, which had been struggling for a while. In fact, WTI crude was at its lowest level since December 2021, weighed down by concerns about lower demand in a slowing economic environment.

The most interesting bit will be what does that mean for inflation. As we just discussed, we were starting to see headline inflation coming down. Obviously, if production is being cut on the oil side, that could renew concerns that headline inflation is going to reaccelerate. We would point out, though, that even if oil goes up 7% at some point, we’re still very far from where we were a year ago when oil prices were closer to $100/$110 a barrel. 

So, even if we do see a bit of appreciation on the oil side, unless we see a dramatic increase, it’s very unlikely that oil prices and energy prices will remain a positive contributor to year-over-year headline inflation going forward, but definitely something to watch.

As I said, it was a relatively quiet week, which gives us the opportunity to focus on the FX market. And on that note, I’m very pleased to be joined by Bhaskar Gupta, Head of FX Distribution in the UK at Barclays Private Bank.

Bhaskar, thanks a lot for joining us again today. I’d like to start by asking you a very broad question, if I may, just to set the scene. Can you tell us a bit and put in context what’s happening in the FX world at the moment?

Bhaskar Gupta (BG): Hello Julien and thanks for having me on the podcast. As always, it’s a pleasure to be here. Well, the last few weeks have been very interesting for financial markets. After all, it’s not often that we see one major bank being acquired by its biggest competitor just in a jiffy over a weekend. And we’ve also seen some of the US regional banks getting into trouble, reminding investors of 2008 and sending a shiver down their spine.

We saw a spike in volatility in March, on the back of these developments, and an extremely choppy price action in bonds and fixed income markets particularly. But in spite of these developments, you know, the FX markets have been relatively quiet and well behaved.

While bonds and equity markets have been the primary drivers recently, FX has taken a back seat and currencies are just reacting to moves in other asset classes with the lack of any direct trigger per se. 

Looking at pound sterling in particular, after some big directional moves last year, it has settled into range trading mode. We saw it weaken significantly last year when the Fed was hiking substantially and the dollar was strengthening, not to mention the Kwasi Kwarteng ‘mini’ Budget. And then we saw the reverse, ie the dollar weaken from its highs as markets gradually priced in an end to the Fed’s rate-tightening cycle. 

But over the last few weeks, sterling has traded broadly, you know, in the 1.19 to 1.24 range and the same is applicable to other major currencies as well. So, the euro has been range-bound in 1.05 to 1.09 broadly. And the sterling/euro cross at an even tighter range, 1.12 to 1.15. So, all in all, currencies have lagged direction and are just in range-trading mode at the moment.

JL: Well, the whole of last year, and even in the first quarter of this year, everything in financial markets, and I suspect in FX as well, was about central banks. Do you think that this is going to continue? And how do you tie that in with the inflation scenario going forward?

BG: Well, when it comes to rate hikes and the central bank outlook, we are at a very interesting juncture at this time. Up until now, with inflation staying high, the central bank actions were easy to predict and in all fairness, you know, the Fed, Bank of England and ECB, they did deliver to what the market expected of them in terms of the quantum of rate hikes. When the market wanted 50, they delivered 50, even 75, and most recently 25. But now all the central banks, you know, they find themselves in a very tight spot, in between a rock and a hard place.

On one hand, while inflation has abated, like you mentioned, from its highs, it still remains elevated and the central banks’ job of bringing inflation down is not over by any means yet. While, on the other hand, all these cumulative rate hikes over the last 12 to 15 months, they have brought us into a new interest-rate regime after 15 odd years, and it’s now starting to show in the economy. 

So, stress in the financial sector is beginning to build up, the Silicon Valley Bank and other regional banks being a case in point. And then there is also the obvious tightening in credit markets. So, we need to remember that interest-rate changes seep into the economy with a lag and it’s only now that we are seeing the effects of rate hikes.

So, yes, central banks are in a very precarious position. If they tighten further from here they risk stressing the markets more and there can easily be another accident. If they loosen rates from here, then they risk inflation coming back which will undo all the good work done so far.

It’s pertinent to note that markets themselves are confused as to what to demand of the Fed and other central banks. And the Fed futures curve itself has had some wild moves and has been rip sawing every week. 

So, in terms of the outlook, I think it’s fair to say that the Fed and other central banks are coming to an end of their tightening cycles but are not fully done yet, or at least they have not communicated that to the markets. The Fed might pause now for a meeting or two and would want to see how the economy is doing, what are the data and other various indicators pointing to, before reassessing a further course of action. In fact, in the last meeting in mid-March, that is pretty much wat the Fed communicated, that their actions will be data dependent. And the ECB and Bank of England might just do the same after maybe one more hike in the next meetings.

JL: So, what does that mean from an FX market perspective, this relative uncertainty? Does that mean that we should be expecting big moves in FX in the near future?

BG: In terms of moves, you know, like I said, obviously, we are at a very interesting juncture. Unlike last year when ‘long’ dollar was a very consensus trade, now the opinion is divided and there is no consensus trade so to speak of. I would say rightly so, you know, given that central banks’ data dependence and the fact that they would, probably they should, give some for earlier previous rate hikes to seep through. 

So, what that means is that every bit of data is important, and the market narrative will flip. We have seen that over the last few weeks. It keeps changing, the new headlines hitting the wires. So, FX will probably continue to be range-bound for some time. In the current environment, the US dollar and, by extension, the Fed’s policy, their statements, their signals, will be the primary mover for currencies. 

We could see the occasional dollar ‘safe-haven’ buying and then we would pretty much see it reversed the next day if we get a different economic metric. So, yes, FX will be choppy but, all in all, range-bound in the immediate term. Over the medium term, we do see some potential for the US dollar to depreciate a bit but, again, nothing spectacular, just a small depreciation towards the end of the year as the Fed will come to an end of their hiking cycle before their European counterparts.

JL: So, how should investors think about those markets? How can they take advantage of it? Are there any trade patterns that stand out for you?

BG: Yes, well, we have been very busy and investors have been taking advantage of the strong dollar all along. Investors that have US asset portfolios and probably euro or sterling as their home currency, have been sitting on sidelines just because of FX moves themselves. So, they have been taking advantage of the strong dollar and have been hedging their US exposure back into their home currency. Typically, FX forwards or zero-cost option structures are quite popular and used for that. 

And secondly, FX volatilities are quite high and they remain elevated. So, investors that are ambivalent to holding any currency, any of the major currencies, they are taking advantage of these high volatilities through dual-currency investments. The high yields on these dual-currency investments are quite attractive given the high FX volatilities used in option pricing, obviously combined with the already high deposit rates. So, they do make sense given the range-bound price action in markets currently.

JL: Excellent. Thank you so much, Bhaskar. That was very interesting. Definitely a market that I think people should be looking at. These are the opportunities as we see them in FX and, obviously, we will keep monitoring them and will bring you back as required, but thanks again.

To conclude, I think the week ahead is going to be a bit busier in terms of catalysts. We have the March ISM number today, on Monday. We’re going to get a lot of job data whether it’s the JOLTS in the US or the ADP unemployment survey, and we’re going to finish with the March nonfarm unemployment report which, obviously, is one of the main numbers that the market is looking at. This, however, will take place on Friday, which will be a bank holiday, so the market won’t get the opportunity to react in real time to that number. But we’ll be back, after a short break, in a couple of weeks to discuss all those recent developments.

Thank you very much for your time and, as always, we wish you all the success in the week ahead and we also wish you, if you have the chance, to take one very enjoyable Easter break. Thank you.

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