GBP Down on Brexit Uncertainty, FOMC Takes Center Stage

10 min readJan 30, 2019

The pound slid against all the other G10 currencies yesterday, as the rejection of Cooper’s amendment and the stance of the EU to not renegotiate may have revived fears over a chaotic EU-UK divorce. As for today, the FOMC decides on interest rates for the first time this year, with the spotlight likely to fall on Powell’s conference and any comments with regards to the recent reports over the balance-sheet reduction. Apart from the Fed decision, investors are also likely to focus on the US-China trade talks.

GBP Slides as Fears of no-deal Brexit Resurface

The pound traded lower against the other G10 currencies on Tuesday. It underperformed the most versus AUD, NOK and NZD in that order, while the currency against which GBP lost the least was CHF.

Yesterday, UK lawmakers rejected Yvette Cooper’s amendment, which includes a nine-month extension to the Article 50, and instead backed a proposal by Conservative MP Graham Brady, who called for the backstop to be replaced with unspecified “alternative arrangements” in the May’s existing deal. That said, a spokesperson for European Council President Donald Tusk said that the backstop is part of the already agreed deal which is not up for negotiation.

The pound tumbled following these developments, perhaps as the rejection of Cooper’s amendment and the adamant stance of the EU may have revived concerns over a no-deal Brexit. Although everyone agrees that such an outcome should be avoided, with no concrete plans on how to move forward, the EU not negotiating, and March 29thdrawing closer, the likelihood of a disorderly withdrawal increases. In our view, sterling is likely to stay under selling interest, at least until lawmakers start reexamining the option of extending Article 50, or even the case of a second referendum. A shift in stance by EU officials, for example, willingness to return to the negotiating table, could also help, but this appears a bit unlikely at the moment. In any case, we believe that GBP-bulls need something suggesting meaningful and concrete actions towards averting a chaotic Brexit before they jump back into the action.

The big gainer was the Aussie, which rallied overnight following Australia’s inflation data for Q4. The headline rate ticked down to +1.8% yoy from +1.9%, instead of sliding to +1.7% as the forecast suggested. The trimmed mean CPI rate held steady at 1.8% yoy. Although the Aussie gained on the somewhat better than expected data, this release is far from suggesting a hawkish shift by the RBA any time soon. Both rates are still below the lower end of the RBA’s 2–3% inflation target range, as well as below the Bank’s projections for the second half of the year, which are also at 2%. Combined with the decision of the National Australia Bank to increase mortgage rates, soft inflation could even delay the RBA from hiking. According to the central bank’s latest quarterly Statement on Monetary Policy, the benchmark cash rate is expected to increase in 2020.

GBP/AUD — Technical Outlook

GBP/AUD took a big hit after yesterday’s UK Parliament vote on Brexit deal amendments. The pair broke below its key support at 1.8300 and fell heavily, which turns our heads to the bearish side. In our view, the slide may continue, at least for a while more, as the British pound is feeling the heat right now.

GBP/AUD is currently trading below a prior important support area, at 1.8213, which now could play the role of resistance. A continued moved south may lead the pair towards a test of the support area between the 1.8105 and the 1.8135 levels, marked by the highs of January 17thand January 23rd, respectively. The pair could find some good support around there or even rebound back up slightly. But if it fails to get back above the 1.8213 barrier, this could quickly get picked up by the bears, who in their case, could drive GBP/AUD back down. A break below the 1.8105 obstacle may lead to a slide to the 1.7995 hurdle, marked by the low of January 21stand the intraday swing high of January 18th.

Alternatively, in order to consider the upside scenario again, we would need to see a push back above the 1.8300 barrier, marked by the low of January 28th. This way, we may see more bulls stepping in and lifting the rate higher, to the 1.8400 obstacle, a break of which could drive GBP/AUD towards the 1.8115 resistance, which is near the high of January 25th.

Will Powel Confirm a Halt in Balance-Sheet Reduction?

As for today, USD-traders will be sitting on the edge of their seats in anticipation of the first FOMC policy decision for 2019. Although this would be one of the “smaller” meetings, where we don’t get any updated economic projections, it would still be accompanied by a press conference. Remember that last year, Fed Chair Powell said that starting in 2019, he would hold a conference after every gathering in order to improve communication. Expectations are for the Committee to keep interest rates untouched within the 2.25–2.5% range, with market pricing suggesting that such an outcome is almost certain. Thus, if this is the case, investors are likely to quickly turn their attention to the accompanying statement and Powell’s remarks at the conference thereafter.

Following the latest meeting, when the Committee decided to hike rates, but to revise down the median dot for the 2019 rate projections, almost all Fed officials, including Chair Jerome Powell, signalled that they could be patient about future rate increases, with the most dovish members suggesting that no more increases are needed. What’s more, on Friday, the Wall Street Journal reported that the Committee is considering maintaining a larger portfolio of Treasury securities than they previously expected, which means halting the balance-sheet reduction earlier. By gradually shrinking its balance sheet, the Fed is withdrawing money from the markets, which is a form of policy tightening. Thus, stopping the process means keeping monetary conditions looser than anticipated.

However, since the previous decision, data haven’t been that bad. Inflation remained near the Fed’s 2% objective, while the labour market has continued to tighten, allowing officials to maintain their sanguine view. Now as far as the economic outlook is concerned, most data suggest a slowdown for Q4, but a slowdown moving forward is already anticipated by the Fed. According to the December projections, GDP is expected to average around 2.3% in 2019 and slow further in 2020 and 2021.

Therefore, with regards to the statement, we expect Fed officials to maintain the view that “some further gradual increases” in interest rates are warranted. The only change we may see may be in the part saying that “economic activity has been rising at a strong rate”. This time, officials may prefer to switch back to the word “solid” instead of “strong”, as was the case in June. We think that the statement is unlikely to include an official announcement with regards to halting the balance sheet reduction. We believe that the topic would probably take centre stage at Powell’s press conference, where he is likely to receive a lot of questions on the matter by journalists. Although Powell may refrain from officially announcing such a step, he may keep the option on the table in case things get out of orbit.

As for the dollar, it could weaken in such a case, but not much. After all, it already tumbled on Friday, when one of the catalysts may have been the WSJ report. For the greenback to fall off the cliff, we believe that an official announcement is needed. On the other hand, in case Powell dismisses the option, which is the most unlikely scenario in our view, the dollar could rally.

USD/CAD — Technical Outlook

Since the beginning of the year, USD/CAD is experiencing a bit of sideways activity, which is not giving a clear indication of where the pair could travel in the near future. That said, recently, USD/CAD failed to move above the 1.3285 barrier, from which it reversed to the downside again. From the short-term perspective, we will target slightly lower areas.

A drop below the 1.3240 hurdle, marked by yesterday’s low, may clear the path towards the next potential area of support, at 1.3203, which is the low of this week. But if the area fails to withstand the bear-pressure, a break of it could force USD/CAD to drop a bit lower, where the rate might get held at the 1.3180 hurdle, marked by the lows of January 9thand 11th.

On the other hand, if USD/CAD makes a comeback above the 1.3285 level, marked by yesterday’s peak, this could result in a short-term higher high. The pair could continue pushing further up, where the next good resistance zone could be at 1.3330, marked by the intraday swing high of January 25th. If that zone is no match for the buyers, then a break above it could lead to another rate-rise, which might end up at the 1.3375 hurdle, marked by the high of January 24th.

As for the Rest of Today’s Events

Apart from the FOMC decision, investors are likely to also keep an eye on the US-China trade saga. Today, Chinese Vice Premier Lui He will travel to the US to hold two-day talks with Treasury Secretary Steven Mnuchin and Trade Representative Robert Lighthizer. Although we may once again get headlines suggesting progress, we doubt a final accord could be sealed in these two days. Last week, Commerce Secretary Wilbur Ross said, “We’re miles and miles from getting a resolution,” adding that there are still lots of issues unresolved, which suggests that, indeed, this round may not be enough for a final deal.

In any case, signs of further progress may keep the door open for more talks and perhaps revive hopes with regards to a resolution before March 1st, when the 90-day deadline expires. Equities and risk-linked currencies, like the Aussie and the Kiwi, are likely to gain, while safe havens, like the yen, could come under selling interest. The opposite may be true if the headline confirms that the two sides are nowhere close to finding a final solution.

With regards to today’s economic releases, during the European day, we get inflation data from Germany, with the nation’s preliminary CPI rate expected to have declined further in January, to +1.6% yoy from +1.7% in December. This could raise speculation that Eurozone’s headline inflation, due out on Friday, may also slow down.

In the US, the ADP employment report for January is due to be released. Expectations are for the private sector to have gained 175k jobs, less than the December’s 271k. This could raise bets that the NFP number, due out on Friday, may also come well below its prior stellar print of 312k. That said, we repeat once again that, even though the ADP is the only major gauge we have for the non-farm payrolls, the correlation between the two time-series at the time of the release (no revisions are taken into account) has been low in recent years. Taking into account data from January 2011, this correlation stands at 0.45.

The 1st estimate of the US GDP for Q4 was also due to be released but the Bureau of Economic Analysis said on Monday that the release will be delayed due to the effects of the government shutdown.

With regards to the energy market, we have the EIA (Energy Information Administration) weekly report on crude oil inventories and expectations are for a 3.0mn barrels increase after a nearly 8.0mn inventory build the week before. That said, bearing in mind that the API report revealed only a 2.1mn increase, we see the risks surrounding the EIA report as tilted to the downside. A negative surprise may allow oil prices to recover a bit more.

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