Markets Weekly podcast – 22 May 2023

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

As usual, we will start by reviewing last week’s key events in the markets before welcoming our guest speaker. And, today, I’m very pleased to be joined again by my colleague Bhaskar Gupta, UK Head of FX Distribution, to discuss currencies. 

But first, let’s review last week. And, for once, it was a fairly quiet week, at least it felt like it. Investors’ attention was definitely focused on Washington and the discussions around the US debt ceiling. On this particular issue, progress has been minimal, so far. Both sides suggest a deal is within reach, but we have yet to see what such a deal would look like. And, after a pause in talks, there is hope that House speaker McCarthy, as well as US President Joe Biden, who spent the weekend at the G7, in Japan, will be able to reignite talks, as they meet on Monday. 

Despite this ongoing uncertainty around the US debt ceiling, the S&P managed to close up for the first time in three weeks, and broke its six-week streak of absolute changes of less than 1%. The Nasdaq, meanwhile, was higher for a fourth-straight week. So, the market appears to be confident that a deal will be reached in time to avoid a US default. 

Now, in terms of data, US April retail sales were probably the highlight. The 0.4% month-on-month increase in overall retail sales fell much below the consensus estimated. Consensus actually expected almost double that figure. But the detail of the report surprised to the upside. In particular, a decline in gasoline prices led to a 0.8% month-on-month drop in gasoline-station sales, which, obviously, weigh down on the headline figure. If you were to remove that, then retail sales were at least as strong as expected, if not stronger. 

The other key datapoint from last week was the initial jobless claim in the US, which came in better than expected, which fell to 242,000 from 264,000, and the consensus was bang in the middle of those two numbers, at around 250,000. 

If you have some time, and you want to look at this in greater detail, I think it’s fascinating to see how much noise there is in this particular data set at the moment, with several states in the US reporting that fraudulent claims have been impacting the numbers. As such, it’s a bit hard to draw any conclusion from weekly claims, but what we can say is when combined with the US retail sales, the picture is one of a still resilient US consumer, and a still resilient US job market.  

And this is crucial in the debate as to whether the Fed is done or not with raising rates. Fed-speak last week offered mixed takeaways on that front. On one side, Federal Reserve chair Powell said that the risks of doing too much, versus too little, have become more balanced, and that while no decisions have been made with regards to potentially more tightening, the Fed can afford to look at the data and make careful assessment, given the progress made so far. 

On the other hand, the Dallas Fed’s Logan said that data in the coming weeks could show that it is appropriate to skip a rate hike in June, though, as of now, the data do not yet justify a pause.  

And in the same vein, St Louis Fed’s Bullard, who is a non-voting member, also said disinflation has been slower than he would like and that the Fed could, and I quote, take out insurance, by raising rates further.  

Within all that, the market is pricing a limited chance of a 25-basis point hike in June, although that pricing has evolved quite dramatically over the last week. At some point, the odds of such a hike were up close to 45%, before they came all the way back down to 20%. I think the bigger adjustment is taking place a bit further down the line, in terms of the year-end median forecast.  

The market used to price the year-end fed funds rate at 4.42%. At the beginning of last week, that moved up to 4.72%. So, it looks like the market is paying attention to this higher-for-longer message that the Fed is reiterating. 

And, I think, that leads us nicely into our guest segment as, after all, one key factor influencing FX markets is the interest-rate differential. So, Bhaskar, thanks again for joining us today, and let me ask you a very simple question to start with. 

A bit like I mentioned around equity markets last week, FX markets have been relatively quiet, of late. What is going on there, and why are FX markets rather quiet at this point in time? 

Bhaskar Gupta (BG): Yeah, hello, Julien. Good morning, and thank you for having me on this podcast. It’s always a pleasure. Yes, as you rightly say, currencies have been rather range-bound and are lacking any real direction for the time being. Sterling has broadly been in a 1.21 to 1.25 range, let’s say, and euro/dollar also in 1.07 to 1.11. 

This is quite in contrast to what we saw last year. So, wherein, we witnessed large directional swings first, an immense strengthening of the dollar then gave up a substantial part of its gains from Q4 2022 onwards. So, though, having said that, while current price action is rangy, it is not completely directionless and there is a very gradual dollar depreciation that’s been happening over the last six-odd months. 

It can primarily be attributed to the lack of a tailwind for the dollar that it has got from the Fed interest rate hikes, so far. And, as regards why it’s rather quiet, look, more than a year-and-a-half of intense thematic trading for FX is coming to a conclusion.  

So, the pressure points of 2022, that is national gas prices, maybe China, Chinese recession and growth concerns, aggressive Fed hiking, all of these are coming to an end, and have even, somewhat, reversed.  

So, as a result, the dollar has corrected from exceptional expensiveness to trading around fair value, and is now waiting for the next catalyst. So, currencies do seem to be in equilibrium, but I’ll class this as an unstable equilibrium, and even a small trigger could send things into a tailspin. 

JL: OK, great. Thanks, Bhaskar. You mentioned the Fed hikes. What has been happening with them? I touched briefly on that. And what about the Fed versus other central banks, and how do we think they’re going to evolve, going forward? Could that be actually the catalyst that could disrupt the fragile equilibrium we’re seeing in FX markets at the moment? 

BG: Yeah, sure. Well, it goes without saying that central banks are the biggest drivers of currencies, and I like to think of them as owners of their respective currencies. While other factors can create noise in price action of any currency, its overall trend gets decided by the whims and fancies of its owners, if I may say, a case in point being the Japanese yen, which has depreciated substantially due to the dovish stance of the Bank of Japan. 

Looking at the three major central banks, the Fed, Bank of England and the ECB, well, they all had rate-setting meetings in early May, and they’ve all raised rates by 25-basis points. But now the outlook from all of them is different. After a series of hikes over consecutive meetings since early 2022, the Fed finally signalled a pause, with strong emphasis on data dependence, thereby keeping all their options open, for now. 

The Bank of England, on the other hand, explicitly stated they are not giving any steers for upcoming meetings, but were markedly hawkish in their statements. In the post-meeting speech and the Q&A session, the Bank of England Governor said inflation remains too high and more tightening will be required if inflation persists. So, given the unabating inflation in the UK, their stance seems justified, and at least one more rate hike is priced in from the Bank of England. 

And, lastly, the European Central Bank, while it also hiked by 25-basis points, it clearly signalled that there are more hikes to come. Markets are pricing in at least two more hikes from the ECB. Given that central banks have mostly done, or are pretty much done, with the bulk of the rate hikes, their forward guidance now has become the primary driver for FX markets. 

JL: I agree, but let me ask another question. Other than the central banks, which we’ve now discussed, what other drivers do you see that could impact FX markets in the short term? 

BG: Well, from a very high-level perspective, markets have shifted their attention to the key risk around the US debt ceiling, and until it gets resolved it can create significant volatility in all markets, be it FX, rates or equities. 

As to when it gets resolved, how it gets resolved and, assuming it does get resolved like every other previous instance, in the process how close does the US government get to default scenario, all that remains to be seen. But, investors should buckle themselves up for a rollercoaster ride. 

Every new headline can change the direction of travel and create substantial volatility. Just last week there was news from both sides saying a deal, or a resolution, is possible. Then, we heard the news of one party walking away from negotiations on Friday. And then, over the weekend, the Republicans saying no more negotiations until President Biden returns from Japan, from the G7 meeting. 

So, this cacophony of headlines will drive markets for the time being. The main transmission channel will be the direct impact on growth expectations and, hence, on equity valuations. Also, central-bank policy will impact the rates market directly and currencies by default, you know, and will have indirect impacts filtering through from both of these. 

JL: Right. Now, let’s bring it all together and, please, help us understand how you think investors should be positioned in this context. Or, what can they do if maybe they’re a bit more worried and they want to brace themselves for more volatility ahead? 

BG: Well, this is not the first time we have seen the debt-ceiling debate pan out. But until things get resolved and the debt ceiling is raised, the risk of a US default and things going into turmoil does have a non-negligible probability. So, it would make sense, you know, for investors to put certain things on which can help them to defend their positions.  

Fundamentally, we do see the dollar slightly weaker towards the end of the year and in Q1 next year, but that’s based on our fundamental valuations and fundamental outlook. A big risk to these forecasts would be if the US debt-ceiling matter doesn’t get resolved in time, or if we get too close to the edge, there would be a massive safe-haven dollar demand. 

Selling the dollar on such spikes could be a good strategy for the medium-to-long term. In terms of how to brace oneself for such an event, well, with rates hovering around 16 to 17 mark, markets seem complacent and are hopeful of a timely resolution of the debt-ceiling impasse. 

Hedging this apparent complacency may be wise. If this is not resolved in time, there will be a mad rush for safe-haven assets. So, the US dollar, the Japanese yen, Swiss franc and even gold will be the primary beneficiaries. Given the low volumes, buying call options on these safe-haven assets can be a good strategy, both for outright gains and also to balance out the risks in any portfolio. 

JL: Excellent. Well, as always, great to hear your thoughts, Bhaskar. We will certainly have you back on this podcast in the coming weeks. 

Now, before we close, we have a busy slate of data and events to pay attention to this week. Of course, the US debt-ceiling negotiations will be the main focus, but, outside of that, we will get the market Flash manufacturing and services PMI. Those will hit on Tuesday. 

We’re then going to have the UK CPI for April as well as May’s FOMC meeting minutes. Both will hit the tape on Wednesday, and we will end the week with the April US PCE, the Fed’s favourite measure of inflation. On this particular data set, investors are not looking for any fireworks. The headline number should tick up slightly to 4.3% year-over-year, while the core PCE is expected to hold steady at 4.6%. 

And to give you a bit more of an outlook as to what to pay attention to, after this PCE data, the next big economic numbers, before this all-important June FOMC decision, will be the April JOLTS data on 31st May, followed by the May jobs report on 2nd June and, finally, the May CPI report, which will come out on 13th June.  

So, plenty to look forward and ponder before the next FOMC meeting and before the summer holidays. Of course, we will be back very soon to discuss all those but, in the meantime, please let me wish you all the best in the trading week ahead.