Monex Europe: Rising gas prices and new UK leadership

Monex Europe: Rising gas prices and new UK leadership

Currency
Gemengd Geld euro dollar pond.jpg

Simon Harvey, head of FX Analysis at Monex Europe, has published his morning commentary:

GPB

The pound broadly underperformed yesterday as rising European gas prices weighed further on sentiment and the expected current account deficit. However, as energy benchmarks eased further into the day, traders started to retrace early losses and create some headroom between spot pricing and the initial pandemic-induced historic low. At 12:30 BST, the market focus firmly shifted as former Secretary of State, Liz Truss, was announced as the victor of the Conservative Party leadership race.

With 57.4% of the members' votes, her victory broke two records. Firstly, it was the lowest percentage of the vote for any Tory party leader under the current electoral system. Secondly, it was the first time that the preference of MPs in the final round of voting, where they favoured former Chancellor Rishi Sunak, was rejected by the party’s membership base.

As Truss was announced, UK government Gilts began to underperform again, led by the front-end of the curve as bond traders began to price in concerns of wide-sweeping, unfunded fiscal support measures that have been proposed by Truss throughout the election campaign. While this was paired back in the back-end of the curve, with the 10-year ultimately closing the day out just 2 basis points higher, the front-end of the curve remained elevated after rallying 10.4bps on the day.

This was also due to hawkish commentary by external BoE member Catherine Mann, who spoke publicly about her concerns over rates not rising quick enough to anchor inflation expectations. In this speech, Mann alluded to the fact that she may vote in favour of a 75 basis point hike in September, although this view is unlikely to be shared by the core of the committee.

Yesterday’s price action is firmly in the rear-view mirror this morning, however, as rumours that newly appointed Prime Minister Truss has earmarked up to £130bn to cap household energy bills at £2000, almost £1600 below the Ofgem projected level for the average household this winter. The news has eased recession concerns and has provided an instant boost to sentiment, resulting in the pound rising some 0.6% against the dollar, but the longer-term impact on the pound depends on how the bond market digests this potential fiscal package and whether it still causes investors to dump UK government debt due to the increased level of risk over the UK’s debt burden. 

EUR

Price action in the euro was fairly tamed yesterday after the kneejerk reaction lower was faded by traders throughout the morning. After trading 0.7% lower against the dollar in the early hours, the euro ultimately closed the day out with losses trimmed to just 0.2%.

Today, risk appetite in European currencies has received a welcome boost as Germany extends the life of two nuclear plants in order to ease the supply issues in energy markets over the winter months, while there is reported to be greater synergy between German Chancellor Olaf Scholz and French President Emmanuel Macron ahead of crucial EU talks this week over changes in the pricing of energy and the amount of liquidity provided to utility companies that are having to navigate huge swings in energy derivative markets.

The news, coupled with signs of greater fiscal stimulus in the neighbouring UK, has helped lift the euro close to half a percent this morning. The rally in the euro occurs despite German factory order data for July showing a larger-than-expected contraction at -1.1% MoM this morning.

USD

US Treasury markets open today after the long Labor Day weekend and are playing catch-up to the rally in core yields yesterday. However, this isn’t providing the dollar with any support as risk sentiment is boosted by positive energy developments in Europe.

This afternoon, the dollar’s focus is likely to return closer to home as the ISM services measure is released at 15:00 BST, while Federal Reserve Vice Chair Lael Brainard is set to discuss the economic outlook at 17:35 BST ahead of Chair Powell’s speech tomorrow. Although the Fed themselves have marked the end of explicit forward guidance, markets are still reacting to the tone of policymakers' speeches as they aim to keep financial conditions tight while moving to a slower pace of interest rate hikes.

Should Brainard strike the same chords that Chair Powell did just over a week ago at Jackson Hole, the dollar may receive a welcome bid in the afternoon of the North American session.