GBP: The New King

Asia overnight

The sentiment was mixed during Asian trading as investors grappled with concerns surrounding the US debt ceiling. However, their optimism was boosted by China's better-than-expected exports data.

Fig1: China headline news from 09/05/2023

 Source: https://www.finlogix.com/calendar

There were also reports from newswires suggesting that Chinese authorities might announce additional measures to bolster the economy.

Currently, Asian markets were trading with a mixed performance, while S&P500 futures showed a slight decline.

In the G10 foreign exchange market, trading remained within narrow ranges, with the Norwegian krone (NOK) and Euro (EUR) underperforming, while the US dollar (USD) and Japanese yen (JPY) outperformed. 

Kazuo Ueda, the Governor of the Bank of Japan (BoJ), stated that the central bank would discontinue its Yield Curve Control (YCC) policy once inflation consistently reaches 2%. However, this statement didn't come as a surprise and maintained investors' view of the new BoJ Governor as dovish. In March, Japan's wage growth continued to be lacklustre, with real wages experiencing a YoY decline of -2.9%. This data is unlikely to prompt any policy changes by the BoJ.

USD: debt ceiling, regional banks, and the Fed

The short-term outlook for the USD is heavily influenced by the ongoing drama surrounding the US debt ceiling in Congress and the outlook for regional banks in the United States. Market concerns regarding the prospects of regional lenders are unlikely to ease following the recent release of the Senior Loan Officers Survey. Additionally, the political deadlock over the US debt ceiling is expected to continue negatively impacting the USD.

During the day, foreign exchange (FX) investors will closely monitor the high-level meeting between President Joe Biden and US congressional leaders, which aims to resolve the impasse over the debt ceiling. In terms of its impact on the FX market, any signs of progress between Democrats and Republicans towards a potential bipartisan solution, such as a short-term extension of the debt ceiling, could help the USD regain strength across the board. Conversely, indications that the political impasse has worsened may dampen the appeal of USD-denominated assets.

EUR: focus on ECB speakers and more

The recent price action of the EUR following the May ECB meeting indicates that the single currency already incorporates many positive factors. This observation is further supported by my FX positioning data and FX valuation analysis, suggesting limited potential for EUR gains soon.

During the day, market attention will be on the speeches given by ECB's Olli Rehn, Mario Centeno, Philip Lane, and Isabel Schnabel, held this morning during Sydney time. This session will be crucial as investors seek further insights into the bank's policy outlook. However, unless there are any significant surprises in terms of a hawkish or dovish stance, EUR/USD movement will likely follow the broader trends in the USD. The USD's direction, in turn, will be influenced by the prospects of US regional banks and the latest developments surrounding the debt ceiling.

GBP: a new king

The GBP has experienced a notable rally in recent weeks, positioning it as the top-performing currency among the G10 nations this year. The unexpected success story of the GBP, now dubbed the "King of G10 FX," can be attributed to several factors. Firstly, the rebound can be attributed to a series of positive UK data releases in recent months, which were influenced by the significant decline in European energy prices and subsequent improvements in commodity terms of trade. Additionally, the persistent UK inflation, combined with reduced post-Brexit tensions between the UK and the EU, as well as diminished risks of another independence referendum, have enhanced the attractiveness of GBP-denominated assets.

Fig2: Gas prices (Energy prices)

 Source: https://www.finlogix.com/chart

Looking forward, market focus will be on the upcoming May Bank of England (BoE) meeting on Thursday, as well as the latest UK GDP data for March, which will be released on Friday. UK economists anticipates a 25-basis point rate hike from the Monetary Policy Committee (MPC), while maintaining a noncommittal stance on future tightening.

However, I believe that UK rates markets have once again priced in overly aggressive BoE tightening in the coming months, and a reassessment of these expectations combined with potential disappointments in growth data could pose challenges for the GBP, limiting its potential gains.

Furthermore, it's worth noting that the recent GBP rally against the USD and EUR has outpaced the improvements in its relative fundamentals. As a result, GBP/USD appears to be overvalued, while EUR/GBP seems undervalued. Consequently, I expect the current GBP rally to lose momentum soon.

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