What's Behind Sterling's Wild Swings?

Behind GBP's Wild Swings

If we compare how G10 currencies performed on a day-to-day basis, there was nothing interesting in Tuesday's price action because all of the majors continued to range trade against the U.S. dollar. However if we take a look at the intraday price action of the GBP/USD, the story is quite different. In the 20 minutes after 10am ET, sterling dropped 80 pips against the greenback and by 11am ET, it had recovered nearly all of its losses. A similar V-shaped move was also seen in the EUR/USD during the same period although the range was smaller. Since last Friday, these types of wild swings have almost become a daily occurrence in the GBP/USD. While we would love to attribute the move to jawboning by a central banker or economic data, the fact of the matter is that the catalyst is unclear. We know that the swings are happening right before the 11am ET / 4pm GMT London fix. A large amount of sterling also needs to be bought to settle the $23.9 billion cash payment that Vodafone shareholders expect to receive on March 4th from their disposal of the company's stake in Verizon but that only explains the immediate recovery and not the sale of the British pound. Some large players could be using the recent strength in the GBP/USD as opportunity to position for a move lower. Although this morning's U.K. economic reports surprised to the upside, M&A flow is one of the main reasons why GBP/USD is holding above 1.66. Without the Vodafone / Verizon deal, some investors may feel that the currency pair should be trading much lower given last week's disappointing economic reports. We beg to differ and think sterling could move to the top of its recent range especially after Tuesday's economic reports and comments from Bank of England member Ian McCafferty. The housing market continues to fuel growth with loans for house purchases hitting its highest level since 2007. Consumer spending has also improved according the Confederation of British Industry's Distributive sales survey, which rose to its highest level in 3 years. Based on improvements such as these, McCafferty feels that it is "not unreasonable" for rates to rise in the second quarter of 2015, sooner than the BoE's official projections. While he spent some time talking about the danger of a strong currency, he also said the current pound rate is not issue. Revisions to the U.K.'s fourth quarter GDP report is scheduled for release Wednesday but no changes are expected. As a result we continue to expect a positive bias in the GBP/USD.

When Will the Dollar Break Out of its Range?

The U.S. dollar traded lower against all of the major currencies Tuesday with the exception of the CAD and AUD. Economic data was weak where it mattered. According to the Conference Board, consumer sentiment deteriorated in the month of February and manufacturing activity contracted for the first time in 7 months in the Richmond area. House prices increased according to the House Price index but S&P CaseShiller reported slower growth. Fed President Tarullo who is also a voting member of the FOMC this year talked about monetary policy Tuesday but his comments centered around the effectiveness of QE and not how monetary policy should be changed going forward. The dollar weakened slightly on the back of these releases but the ranges in EUR/USD and USD/JPY remain intact. Forex traders have grown tired of attributing weak data to weather related distortions and have become more selective about the economic reports they respond to. Unfortunately Wednesday's new home sales report is not expected to have a significant impact on the greenback. FX traders may have to deal with the consolidation for another week and a half as we won't get a true sense of how the economy is doing until March. Next month's non-farm payrolls report on March 7th could still be distorted by the weather but it is first piece of market moving U.S. data that could potentially break the dollar out of its range. Between now and then, a number of Federal Reserve officials including Janet Yellen will be speaking but we don't expect them to front run the NFP report and signal a change in monetary policy. Fed Presidents Rosengren and Pianalto are speaking Wednesday but they are not voting members of the FOMC. Meanwhile it will be very difficult for the dollar to rally without a significant rise in U.S. yields. Like FX traders, fixed income traders are patiently waiting for more relevant data on the U.S. economy before driving yields in one direction or the other.

EUR: EU Raises Eurozone Growth Forecasts

The ongoing turmoil in the Ukraine continues to hamper the rally in the euro. No major Eurozone economic reports were released this morning but Q4 GDP growth in Germany was confirmed at 0.4%. The lack of a surprise meant a lack of reaction in the EUR/USD. We continue to expect a bullish bias in the EUR/USD this week. In yesterday's note, we wrote about how the currency should benefit from market sentiment, stronger Eurozone data and weaker U.S. data. The European Commission's decision to upgrade its euro-area growth forecast is also supportive of the currency. Previously they expected the economy to grow 1.1% in 2014 and 1.7% in 2015 but now they expect 1.2% growth this year and 1.8% growth next year. They also lowered their jobless rate forecasts but to the ECB's dismay, they cut their 2014 and 2014 inflation forecasts. Like the central bank, they feel that the "downside risks continue to prevail." Where they differ is they feel risk of the deflation is low but "cannot be ruled out." The central bank believes there's no risk of deflation. Either way, slow price growth will keep monetary policy easy. Unlike some economists who are looking for a rate cut next month, we believe the ECB will keep rates steady.

USD/CAD: Supported by Sell-off in Oil

While the Canadian and Australian dollars weakened against the greenback Tuesday, the New Zealand dollar held onto yesterday's gains despite a small decline in inflation expectations. No economic data was released from Canada or Australia but lower oil prices helped USD/CAD rebound after yesterday's losses. The Australian dollar on the other hand saw no benefit from the rise in gold prices. For the most part, it appears that the commodity currencies sold off because equities failed to extend their gains. The losses were small which is a greater sign of hesitation than weakness. There's no major Australian or Canadian economic releases scheduled over the next 24 hours but New Zealand will release its latest trade numbers Wednesday afternoon (Thursday morning local time). Despite the overall strength of the economy, the country's trade surplus is expected to decline as exports slow. Meanwhile the Chinese Yuan continued to fall, dropping to its lowest level since September. Since last Thursday, Chinese stocks have fallen nearly 5% and if they continue to lose ground, it may spillover to the major currencies like AUD/USD and USD/JPY.

JPY: Japan's Pace of Recovery is Slowing

Despite the overnight rally in the Nikkei, the Japanese Yen traded higher against all of the major currencies. The sell-off in Treasury yields and the slide in U.S. equities contributed to the move as Japanese investors ignore the deterioration in data. Inflationary pressures have eased according to the corporate service index, which dropped to 0.8% in January from 1.1% the previous month. Small business confidence also deteriorated with the index slipping to 50.6 from 51.3. Over the past month, we have seen plenty of evidence suggesting that the pace of recovery slowed at the end of last year and beginning of this year. Japan really needs regain traction if they want to create enough of a buffer to withstand the contraction that is expected after the consumption tax increase in April. If economic data does not start to improve soon, the Bank of Japan could resort to easing monetary policy.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.