Pound Finds Support on Dale’s Comments, as Risk Appetite Wanes

GBP/USD

The British pound has found support for a third straight day despite waning risk appetite as hawkish comments from BoE chief economist Spencer Dale generated support. The MPC voting member warned that policymakers need to be wary of driving up asset prices with loose policy.  The statements increase the odds that the central bank will terminate their asset purchase program, which Dale voted to keep on hold last month when an additional 25 billion pounds was allocated. We continue to see interest rate expectations grow in importance, currently explaining 26% of price volatility, as the end of quantitative easing will start the clock on future tightening. Prior strength was derived from a return of risk appetite which reversed the bearish reaction to the Dubai debt scare. Risk trends remain the primary driver of the GBP/USD’s direction with a 33% correlation and with major event risk at the end of the week must be accounted for when trading the pair this week.

BoE Interest Rate Expectations

Despite the hawkish comments from Chief Economist Spencer Dale the MPC isn’t expected to raise rates over the near-term as the U.K. economy remains in a recession with a 0.3% contraction in the third quarter. Rising inflation risks could force the central bank’s hand, but at this point that would be willing to accept an increase in prices to guard against a deeper recession. Economists are already forecasting that the BoE will leave their target rate at 0.50% next week. Meanwhile, Overnight Index Swaps are only pricing in 58 bps of tightening over the next twelve months. Fundamentally the economy continues to show signs of improvement with the construction PMI for November improving to 47.0 from 46.2 and expectations for tomorrow’s reading for the service sector to show continued expansion. The non-manufacturing sector accounts for 70% of GDP and if its current trend of expansion appears sustainable, policy makers would be more willing to remove stimulus efforts. To discuss this and trading ideas join the GBP/USD forum.

FOMC Interest Rate Expectations

U.S. interest expectations have flat lined with markets only pricing in only a 8.9% chance of a rate hike by March. It isn’t until September that we see a rate hike as the most likely possibility according to Fed Fund futures. November’s labor report scheduled for release on Friday holds the largest potential to alter policy maker’s direction. Non-Farm payroll jobs are expected to have decline by 123,000 which would be the lowest since March, 2008 and a print close to even could raise expectation for job growth and in turn tightening from the FOMC. Regardless, the main catalyst for a rate hike from the central bank will be inflation, which remains off in the distance with prices still declining.

Risk

The Dow has given back some of its gains from yesterday as a drop in oil prices weighed on energy names. Upside potential remains with a test of trendline resistance near 10,600 still a possibility. However, with major event risk ahead and current valuations more than 20 times earnings, the path of least resistance could be lower. An unexpected rise in U.S. crude inventory levels may reignite consumption concerns and become a weighing factor for equities if the upcoming labor data disappoints. To discuss this and other fundamental data join the Economics Forum.

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com