The Pound Sterling – in the eye of the storm?

The currency market saw some calm at the beginning of the week as the US commemorated Indigenous Peoples’ Day on Monday. After flirting with parity against the euro at the beginning of last week, the dollar resumed its advance. On Friday, the US Department of Labor announced 263,000 jobs had been created in September after 315,000 in August. Economists were expecting a sharper slowdown at around 250,000 new jobs. The unemployment rate fell from 3.7% to 3.5%. Average hourly earnings rose by 0.3% after a similar increase in August, for a year-on-year increase of 5.0%, compared with 5.2% in August. This data makes it all the more likely that the Federal Reserve will raise its benchmark rate by another 75 basis points at its next meeting on 2 November to a bracket of 3.25% to 4%. Interest rate derivatives are showing a 3-month Libor of 6% for December this year and Treasury yields are soaring. At 3.99%, the US 10-year bond hit levels not seen since late 2007, the last time the rate was above 4%. Although there are some worrying signs of a slowdown, such as job cuts in certain sectors like transport and distribution, the dollar seems unstoppable at the moment.

In the eurozone, too, rates are on the rise, but the spread remains largely in favour of the greenback. The minutes of the ECB’s last monetary policy meeting showed its concern about inflationary risks without a sharp rise in key rates. The ECB raised these by 75 basis points on 8 September, the largest increase in its history. It is therefore planning further hikes in the coming months to combat inflation, which has accelerated further to 10%, a level not seen since the creation of the euro. The next monetary policy meeting will take place on 27 October and most analysts expect another 0.75% raise. The President of the Dutch central bank, Klaas Knot, said that the ECB is likely to make at least two more significant rate hikes at its next two meetings. This is the case even though there are some clouds on the horizon for the economy. Inflation and the consequences of the war in Ukraine are making a recession increasingly likely.

The pound has experienced a period of very high volatility over the last two weeks (see the Weekly Brief of 5 October). After rising from its all time low against the dollar at 1.0350 to 1.1495 on Thursday, the British currency has again fallen back below 1.1000 this morning. Prior to the recent volatility, expectations were for further monetary tightening by the Bank of England, given the persistently high inflation in the UK. While the sterling has recovered from its collapse, the outlook for the UK economy remains very fragile. Expectations are now divided as to whether the BoE will take rates up by another 50 basis points, as originally planned, or by more. Last time, three members voted in favour of a 75-point increase. The unemployment rate, published yesterday, surprised analysts by reaching 3.5%, the lowest since 1974. This news would have normally reassured the central bank if it were not inflationary in nature and did not hide another reality. The number of people who are out of work and not looking for work for various reasons (illness, study, etc.) is at its highest since the beginning of the statistics in 1971. More than 252,000 people have become economically “inactive” in the last three months. Rising inflation and the associated cost of money and a worsening economic outlook are creating further turbulence for the British currency.

The Japanese yen is another victim of the strong dollar and a very unfavourable interest rate spread. The dollar touched 146.39 yen this morning, surpassing the 145.90 mark that had triggered the Japanese authorities’ intervention last month. The greenback is now trading at a 24-year high against the yen. US and Japanese long-term bond yields continue to move away. The yield on 10-year Treasury bonds is flirting with 4% like we mentioned above, while the equivalent yield on Japanese government bonds remains steady at 0.25%.

The release of the minutes of the last Fed meeting and US inflation data today and tomorrow will be of particular interest and should give an indication of how big the next rate hike will be in the US.