Markets Weekly podcast – 5 February 2024

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

Unlike the previous weeks so far this year, I’m going to be joined by a guest this week. Bhaskar Gupta, Head of FX Distribution for the UK here at Barclays Private Bank, is going to join me to discuss everything FX.

But, before that, let’s take a quick look at last week, which was one of the busiest of the year. US equities ended the week mostly higher, shaking off a big slide on Wednesday. And again, big tech was the major driver of index performance, with five of the ‘Magnificent Seven’ names reporting Q4 earnings, and the results were pretty solid across the board.

Now, the other big topic for last week was the January FOMC meeting, and the US Federal Reserve (Fed), as expected, held rates steady. But the real focus was always on what signal chair Jerome Powell would send around the trajectory for future interest rate cuts. And while chair Powell was pretty clear, and probably also for the majority of the FOMC, we’ll figure that out when the minutes of the FOMC are released, but there seems to be a consensus that a March rate cut is, and I quote, “not the base case”. That resulted in markets pushing back their expectation for the Fed’s first interest rate cut from March to May or even June.

Now, closer to home in the UK, we also had the Bank of England (BoE). And, again, as expected, the BoE decided to keep interest rates on hold for the fourth consecutive meeting. The MPC voted 6:3 to keep the rate at 5.25%, and the main development was the fact that the central bank dropped its tightening bias, suggesting a potential shift towards an easier policy stance in the coming months.

The other main release of last week, from a data standpoint, was obviously the nonfarm payroll in the US. In January, those came in much hotter than expected, up to 353,000, when the consensus was looking for only 177,000. Not only that, but the previous two months were revised higher. In addition to that, average hourly wages were very hot, at 4.5% year over year. The market was looking for just 4.1%, and the November figure was also revised higher.

Now, importantly, the average workweek shrunk to 34.1 hours, that was down from 34.3 hours in December, which means that when you combine those two things, average weekly earnings rose by only, so to speak, 2.96% in January. There were also a lot of seasonal effects at play here, so while it was a strong report at the headline level, it probably wasn’t as strong as that headline figure suggests.

Now, taking all this together what does it mean for investors? Well, the consensus seems to be evolving and moving from a soft-landing scenario to a no-landing scenario. And, as we mentioned last week, this momentum will likely persist until a series of datapoints starts missing expectations. Now, that could still be a few weeks away but eventually expectations will get too high and data will start disappointing, and investors need to be mindful of not getting caught wrong-footed when this pendulum starts swinging the other way.

Now, let’s move on to our guest segment and discuss FX markets. Bhaskar, thanks again for joining us, always a pleasure to have you on the podcast. Well, we’ve seen quite a lot of volatility, especially on the rate side, maybe a bit less so on the equity side. The FX market seems to have been trading in a relatively tight range in recent weeks. So, what’s the reason for that? What early observations can you make when you’re looking at FX markets in the beginning of 2024?

Bhaskar Gupta (BG): Hello, Julien, and a very good morning to you, and thank you for having me on the podcast. Yes, as you mentioned, the major currencies have been extremely rangebound for the last couple of months. That’s been to everyone’s dismay, if I’m honest. 

If you look at just the bisection in cable, that in itself says it all. Over the last six weeks, let’s say since mid-December, it has been in a 1.26 to 1.28 range, hovering pretty much half a percent on either side of 1.27. Its volatility, as in the metric that is used to price-up options, is reflecting this as well, and cable one-month has gone below 7%. This is way lower than its usual levels.

Just to give our listeners a perspective, it was around 8%, 9% or even 10% for the whole of last year and it was at a good 11%, 12% in 2022, when episodic spikes of up to 20% to 21%. Say, for example, in the aftermath of the Kwasi Kwarteng budget that September.

But, anyway, coming back to the present, the simple fact is that none of the macro drivers presently, or flows for that matter, are compelling enough to break these ranges. There isn’t a strong narrative that can disturb this equilibrium and, hence, we are seeing the price action, or lack of it, to be rather dull. 

And the same is reflected in other major currencies, with the euro having traded in a broad 1.08/1.10 range. Again, a very tight range.

JL: Right. So, you mentioned that there is some kind of equilibrium in FX markets at this point in time. Is there anything that you think could break that equilibrium and, as a follow-up question, if that were to happen, which currency do you think would benefit the most?

BG: Well, markets do have a knack of erupting on something or the other when one least expects them to, and such periods of low volatility do not tend to stay for long. The central banks are the biggest driver of overall direction for any currency, and just in the week gone by, as you’ve mentioned, we have had quite a few central bank meetings, notably the Fed and the Bank of England, both of which remain noncommittal and stuck to their scripted tunes.

As regards the Fed, the tightening bias was removed from their statement but, yes, the bar was raised for a March rate cut. Chair Powell said the FOMC needs to see more good data to gain more confidence, and suggested that a cut was not likely in March.

In similar vein, the Bank of England followed the Fed and kept rates on hold. Their Monetary Policy Committee modified its guidance to remove the hawkish bias, replacing it with a non-directional commitment to adjust policy as warranted. The general tone of the messaging at the press conference was also that, you know, we have come a long way but we are not there yet, so they did say more evidence was needed before they can start cutting.

So, while both central banks are singing from the same hymn sheet for now, this could change. As much as last year was the year of consensus, this year it doesn’t feel like that will be the case. So, for now, while the markets are pricing in five to six rate cuts from the Fed, or four or more rate cuts from the Bank of England, that seems to be on the higher side. Central banks are not obliging the market, and this could be a source of significant volatility.

So, each of their meetings will have heightened risk for now. On balance, we judge the macro environment to still be favourable for the US dollar, so we do expect the dollar to strengthen in the short term.

JL: So, yes, if we do expect volatility to ramp up throughout this year as central banks give us more colour and detail as to what the next move might be, it’s fair to say, as I mentioned earlier, that volatility has been fairly subdued in FX markets so far. For investors, I guess it’s fairly easy to understand how to benefit in a volatile environment. It might be a bit more complicated to see where the opportunities are when volatility is low. So, what would you do in an environment like this one, where volatility is rather subdued?

BG: Well, that’s a very good question, Julien. And, yes, the nature of FX markets is such that there is something that can always be done, depending on the state of the market. So, the current low FX volatility means that FX options are cheaper and that means that the risk/reward is favourable for investors that are buying options, be it for hedging purposes or for speculation.

Especially for investors that need to hedge their foreign-currency exposure, they can use options to hedge their downside risk, and that comes at a cheaper-than-usual price. Think of it as getting your annual car or home insurance at a discounted price. Similarly, for investors wanting to put on a speculative trade, buying short in, let’s say, one-month/three-month options at the current cheap prices, could give them a handsome return if the currencies break-out of their ranges.

The risk/reward is more favourable in going long options when volatilities are low, and that is something that investors can use to their advantage in the current environment.

JL: Believe me, I wish I could get my car insurance for a discount. Anyway, here’s the last question. I think it’s important that we touch on this, because there are many risks out there, not just focused on FX, but maybe there are some that are particular to FX. So, what are the risks that you see ahead? What do you think investors should be watching out for when it comes to the rest of this year?

BG: Well, a lot has already been said in the global press about 2024 being a mega-election year across the world, so, yes, that will have a bearing on markets in general, and, obviously, that is something investors need to watch out for. We’ve also had the Israel/Hamas conflict, the Middle East uncertainties, the more recent Houthi rebels trying to dislodge freight in the Red Sea and then the counter-attack by the US and the UK. So, these geopolitical issues will add their bets to the risk premium. These are the ‘known unknowns’ if I may say. 

To me, the greatest risk for currencies in particular, and financial markets in general, is the non-consensus between market expectations and central-bank action.

As I said earlier, markets seem to be pricing in too many rate cuts this year and the central banks, so far, seem to have been pushing back against them. The central banks are well aware that the dangers of cutting too soon are far greater than going a tad later, and they have declared data dependence to be their mantra for the year. So, the market expectation is going to be repriced with each incoming data, and we could see wild swings in it if the economic data itself flips about.

We got a glimpse of it last Friday, as you mentioned, when after a bumper US payroll number, the entire US yield curve shifted almost 15 to 18 basis points higher, and the dollar strengthened close to a percentage. A weak economic number could easily have done the reverse. So, this non-consensus between markets and the central banks could be a big source of volatility this year.

JL: Yeah, this is something, Bhaskar, that we discussed last week and in the weeks prior to that. The fact that in December the market was expecting almost a 100% chance that the Fed would cut in March, while now we’re blow 20%, so a huge shift there. It hasn’t necessarily translated into equity markets, and I think a big reason for that is we’ve seen earnings taking precedence over the macro picture in recent weeks. But, clearly, from a rates perspective, as you mentioned, there were significant moves and potentially that could have a repercussion in FX down the line.

Anyway, thanks again for coming on the podcast today, Bhaskar. We’ll have you back very soon, I’m sure. 

Now, before I conclude, a quick look at the agenda for this week. It’s going to be slightly quieter. We still have a bunch of earnings to go through. I think 104 companies in the S&P 500 will report earnings this week, as well as a few in Europe. Beyond that, from a macro perspective, we’re going to get the ISM services for January at the beginning of the week, followed by the Fed’s bank-loan officers survey. 

We will move on then to the RBA decision and ECB inflation expectations, that will be on Tuesday. And we’ll finish the week with an important read on US inflation, with the revisions to CPI and, as we discussed today, all datapoints might have a bearing on market expectations.

Finally, well, it’s the week after the FOMC, so you could expect a lot of FOMC members to go on the media and talk about their view for interest rates. Actually, chair Powell started that yesterday evening by being on TV in the US in the ‘60 Minutes’ show, basically just reiterating what he said at the press conference last week.

Anyway, probably a lot that we’re going to have to digest and that we’re going to debrief next week. In the meantime, as always, we wish you all the very best in the trading week ahead.