Ebury: Sterling pummeled as Brexit fears haunt markets

Like a sequel to a bad horror movie, the latest episode in the Brexit saga is reviving fears of a complete breakdown of Brexit negotiations and the attendant economic and financial chaos. The main victim was the Pound, down over 3% against every major currency worldwide.

By Enrique Diaz-Alvarez, Chief Risk Officer.

Aside from the volatility in Sterling, it was a relatively quiet week in currency markets, and all the majors moved in fairly tight ranges. Away from FX, a noteworthy move was the divergence between US and European stocks, as the latter rallied while the former fell sharply, helping close some of the outperformance of US equities during the pandemic.

This week, in addition to Brexit headlines, central banks will be the focus in currency markets. After the ECB meeting last week turned out to be a relative non-event, the Federal Reserve on Wednesday and the Bank of England Thursday will share their latest thinking on the pandemic and the recovery, though no major actions are expected from either.

GBP

Decent economic numbers out of the UK were completely overshadowed by Boris Johnson's government threat to break international law and renege partially on the Brexit divorce treaty. Sterling was mercilessly pummeled all week as a result. This week, the mounting internal resistance to Johnsonñs move within the Conservative party may provide a respite to the Pound. On Thursday, the Bank of England meeting will provide another focus for currency traders. While no change in policy is expected, there may be votes for immediate additional QE, and short term moves in the Pound should take their cue from them. A unanimous MPC with no dissenting votes may well provide some support.

EUR

The ECB September came and went, and the central bank gave few signs that it was worried either by the shortfall on finlation or by the sharp rise in the Euro. As to the former, it seemed to adscribe the recent collapse in core inflation to technical issues related to seasonality, and clearly expects most of the surprise to be reversed in the coming months. As to the latter, it suggested that current levels of just below 1.20 dollars are not a significant worry. In the absence of critical economic data, the EUro´s trading this week will be driven mostly by events elsewhere, in particular the Federal Reserve meeting on Wednesday.

USD

Economic data out of the US continues to defy expectations and point to a faster than expected recovery. So far, there is little sign that markets are fretting over the upcoming presidential election, where the main risk continues to be that of a disputed election that is not resolved on election day. All eyes turn now to the Fed meeting Wednesday. This is the first meeting after the Fed adopted a flexible inflation targeting approach in late August, and the market is expecting concrete guidance on what this will mean for monetary policy. One crucial data point will be the dot plot expectations of interest rates for 2023, which will be included in the September release for the first time. If the median FOMC member expectation remains at zero, the dollar may suffer, as it would further confirm the Fed's willingness to take inflationary risks in order to support growth.

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