Well! I have to say I was surprised. Even if the net result is that GBP/USD is going down as I have been expecting, I didn’t think it would go down in quite this way. Yesterday, ‘Super Thursday’, the Bank of England published its Inflation report; the votes for the decision to stay on hold; and the meeting minutes. As I said in yesterday’s blog, there was a chance that recent stronger UK data might push some wavering hawks towards recommendations for rate hikes. No such thing happened. The vote remained the same as it’s been after recent meetings, and furthermore the Inflation Report suggests rates could remain on hold for longer than expected.
All the recent economist and trader polls which have suggested that hikes might come sooner than previously thought got it spectacularly wrong. The whole City has egg on its face quite frankly. This points to a divergence between the likely actions of the Bank of England and Federal Reserve in the coming months, so no surprise than GBP/USD got punished yesterday. This isn’t likely to stop anytime soon. I’m still trying to get my head round how the market could have got it so wrong, and I have a rather cynical thought as to the reason why.
As I mentioned in a recent blog, the structure of the UK’s current account deficit has changed since the global financial crisis. Whether by dint of historic empire or some other reason, the UK used to earn more from international investments than foreigners did from their investments in the UK – an investment surplus. But the huge issuance of government debt in the last decade has put paid to that. So where, in the past, the UK used to earn a healthy investment surplus but ponder about how to fix its persistent trade deficit, the investment deficit has now become a burden to the UK basic balance. My cynical thought is this… what if Messrs Carney et al, are afraid of increasing the investment deficit by allowing gilt yields to rise (which would probably happen if interest rates started to go up)? What if they see a weakening of the pound sterling as the solution to the problem, because it might help make British products more competitive abroad? Perhaps more importantly, currency depreciation would boost the sterling value of UK overseas investments, thus reducing the investment deficit. What if indeed? If that’s what they they’re doing, they are walking a very tight line. If the market rumbled to it, GBP and the gilts market might collapse. Anyway.. it’s just my idle speculation, so feel free to disregard it.
Today is non-farms payrolls in the United States. The all singing and dancing labour market report that’s published at the start of every month. Following Chairwoman Yellen’s recent testimony to Congress, it’s clear that a US interest rate hike is a real possibility in December. So any signs today that the recent deceleration in jobs growth was just some sort of temporary blip and the probability of an interest rate hike would increase dramatically. All eyes will be on this report. It’s not just the dollar that would react strongly to this data. I rather suspect that equity markets would not react positively to strong employment growth, nor do I think would emerging market assets which have only recently been recovering from the China woes of a few months back. This could be a rocky day indeed!
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