Ellie Allen

Risk Rally Sees Pound Hold Onto Strength as Dollar Slide Continues


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Throughout August the Pound continued to hold onto its strength, rising against the majors and only slipping back against trade sensitive currencies as risk appetite strengthened. Versus the US Dollar, Sterling surged higher, shrugging off concerns around alarming UK economic news and taking advantage of a change in strategy by the Federal Reserve. The Fed indicated it would no longer be keeping such a tight rein on inflation, a move that generally dampened demand for the Greenback.

BANK OF ENGLAND INDICATES STIMULUS MEASURES ARE HERE TO STAY

Bank of England (BoE) governor Andrew Bailey sought to allay fears over the UK economy by implying QE (quantitative easing) would be longer lasting and more extensive than previously planned. Saying “We are not out of firepower” Mr Bailey, speaking at the Jackson Hole conference, went on to explain that with the benefit of hindsight central banks had been “too cautious” when it came to stimulus measures, and that by “going in big and fast” the UK economy could be pulled out of its current state of torpor.

Markets were generally unimpressed by the Bank chief’s comments, although the Pound remained stable. The backdrop to the BoE message was news that the UK economy may have been hit harder than other major economies and faces a prolonged recession due to an ‘incompetent’ handling of the Covid-19 crisis.

US DOLLAR CONTINUES ITS SLIDE AS FED CHANGES COURSE ON INFLATION AND RISK APPETITE RETURNS

August proved to be another difficult month for the US Dollar as surging global risk appetite dented demand for safe haven currencies, keeping USD on the downward trajectory it has been on since April. The US Dollar index (DXY) now stands at 92.3.

The standout news this month was that the Federal Reserve had made its biggest inflation policy change in decades. At the Jackson Hole (online) conference, Fed Chair Jerome Powell told his audience that the US central bank would no longer be targeting a 2 percent level of inflation and would instead allow it to ride higher until the economic damage caused by the Covid-19 lockdowns has subsided. The stated aim of this loosening of inflation policy was to help reduce unemployment. This new soft approach to inflation was a surprise to markets, and USD briefly burst higher, although it fell back again later.

A further factor affecting the US Dollar was the shock resignation of Japanese PM Shinzo Abe citing health reasons. His stepping down had the effect of strengthening the Japanese Yen, which is a competitor safe haven of the US Dollar, thus drawing demand away from USD.

Having started off the month at $1.31, GBP/USD rose to $1.34 by the end of August, with the majority of gains seen in the last week.

Meanwhile, the Canadian Dollar strengthened against the Pound during the early part of August only to fall back again towards the end of the month to finish off unchanged. One of the drivers for this rebound was Canadian GDP figures, which proved to be stronger than anticipated over the short term, but weaker than expected on the more important annualised basis. GBP/CAD began the month at CA$1.75 and ended unchanged, despite dipping as low as CA$1.72 in the meantime.

EURO BENEFITS FROM INPROVED ECONOMIC SENTIMENT AND WEAKENING DOLLAR

The Euro put in another strong performance in August, strengthening to a new 27-month high against the US Dollar. One of the reasons for this was a pick-up in economic sentiment across the Eurozone bloc, including some better-than-expected employment figures. Nevertheless, Euro gains were capped by concerns about the increasing number of Covid-19 cases being detected across the region, with investors fearing new national lockdowns.

Despite this strength, the Euro still slipped against Sterling, with one Pound buying €1.12 by the end of the month compared to €1.10 at the beginning. Investors shrugged off concerns about the likelihood of the UK and the EU failing to reach an amenable Brexit deal, choosing instead to focus on improving global risk sentiment. The EU’s lead negotiator, Michel Barnier, said that a deal “seems unlikely”.

With the Euro having exhibited a bullish streak since mid-May, analysts are starting to wonder whether this is now coming to an end. Despite the strong backward-looking economic data published for the Eurozone in August, flash PMIs suggest the economic resurgence could be running out of steam. Combined with the concerns over the rising number of Covid-19 cases, this is serving to make investors wary on the single currency.

AUSTRALIAN DOLLAR MAINTAINS STRENGTH AS CHINESE ECONOMY IMPROVES AND RISK APPETITE HOLDS UP

In light of better risk conditions, the Reserve Bank of Australia (RBA) opted to keep interest rates on hold, conceding that additional fiscal stimulus will be needed going forward. RBA Governor Philip Lowe stated “The Australian economy is going through a very difficult period and is experiencing the biggest contraction since the 1930’s. As difficult as this is, the downturn is not as severe as earlier expected and a recovery is now underway in most of Australia.” Despite this, the “Aussie” continued to gain in strength over the course of the month, bolstered by a recovering Chinese economy – Australia’s biggest trade partner – and a greater willingness to invest in trade sensitive currencies due to the aggressive stimulus measures being enacted by central banks.

As a result, Sterling slipped back against the Australian Dollar, with the GBP/AUD currency pairing falling from AU$1.83 at the start of the month to AU$1.81 by the end.

WHAT TO LOOK OUT FOR IN SEPTEMBER

Despite the generally positive global risk sentiment we have seen in August, September could see a change as a number of factors draw together to influence the outlook. Chief amongst these is the ongoing coronavirus problem, with markets jittery about localised resurgences in case numbers. Any resultant national lockdowns could have widespread knock-on effects for global trade, reversing recent gains seen in risk sensitive currencies.

At the same time, widespread unrest on the city streets of America is continuing to make USD investors nervous, especially as the November election draws closer. The protests and violence seen in recent days could have the effect of dampening Dollar demand further if the sense of crisis escalates any more. Despite robust US economic numbers, further coronavirus outbreaks across states, and an uncertain election ahead, are causing investors to hold their breath.

For the Pound, whether the currency can hold onto its recent strength may come down to how Brexit talks with the EU pan out. Germany’s Angela Merkel has said talks are likely to “go down to the wire” conceding that little to no progress has been made so far. In other EU news to keep an eye on, Greece and Turkey are in a dispute over drilling rights for oil and gas in the eastern Mediterranean basin. Should there be a flare up over this disagreement we can expect to see Euro sentiment take a hit.

The Euro remains on shaky ground at present, with markets focused on the likelihood of the single currency being at the end of its recent bull run. Economic fundamentals remain unproven and surging Covid-19 cases threaten to derail the Eurozone’s recovery.

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