Sterling rises, Yen falls as markets look past French election

he winner of the week was Sterling which continues to move towards our targets as the bearish consensus on the Pound is unwound. The worst performing major currency was the Japanese Yen, which was hammered by traders after the Bank of Japan lowered its inflation forecast and signalled that policy normalisation is nowhere in sight. Special mention goes to the South African Rand, which is struggling to find a range after the dismissal of Finance Minister Gordhan and the subsequent downgrades by credit agencies.

Focus now shifts to a raft of central bank meetings this week. The Federal Reserve will dominate headlines on Wednesday, but we also get updates from the Reserve Bank of Australia on Tuesday and Norges Bank on Thursday.

Major currencies in detail

GBP

The massive short position that market participants had put on against Sterling continues to be unwound, and the resulting short covering rally has turned the Pound into the strongest G10 currency in April. However, the rally is looking a little stretched, and the latest news from the Brexit negotiations are less than encouraging – this may provide the catalyst for some short-term profit taking in the Pound.

Next week, local elections will provide an early test for the major parties on the way to June’s general election. The PMI indices will shed some light on whether the slowdown seen in first-quarter growth is temporary.

EUR

The big news of the week was the ECB meeting. President Draghi acknowledged the improvement in economic conditions across the Eurozone, but he sounded a worried note about the inflation miss in March, and seemed convinced that inflation will not reach ECB targets unless stimulus measures are kept in place for a very long time. As a result, changing policy guidance seemed to be completely off the table – it wasn’t even discussed at the meeting. Overall this is exactly in line with our views. However, the market had built up expectations for some discussion on bringing forward the timeline for either hikes or paring down QE. The Euro wobbled in the hours after the meeting, and only found its footing after April flash inflation turned out to be considerably larger than expected.

The next key date in the Eurozone is the second round of the French Presidential elections. The gap between Le Pen and Macron narrowed slightly last week, but remains around 20 points. There has never been a poll miss of this magnitude in a major election in recent memory, and markets as well as ourselves appear fairly relaxed that it will not happen this time.

USD

The Dollar shrugged off weak first quarter growth data last week. It is worth noting that absent a temporary failure to build inventories, growth would have come out to around 1.7%, not far from what consensus regard as the US cruise speed.

The Federal Reserve meets on Wednesday, and is universally expected to leave rates on hold. More critical will be the communications from their Open Market Committee (FOMC). We expect them to pencil in another hike for the June meeting. Given that the market has only priced in a 70% chance of this happening, that should be enough to provide support for the Dollar.

A firming in the so far vague fiscal plans of the Trump Administration would also be positive, since at current levels in Euro-Dollar, the market appears to have priced out any chance of a meaningful tax package being enacted this year.