British Pound Volatility Risk High as BoE Updates Rate Outlook

Talking Points:

• Dollar Weighs Cross Currents Against Domestic Data
• British Pound Volatility Risk High as BoE Updates Rate Outlook
• Euro: Investor Sentiment Collapses, Will Stalled Growth Complete the Picture?

Dollar Weighs Cross Currents Against Domestic Data

An attempt by the Dow Jones FXCM Dollar Index (ticker = USDollar) to break free of its two-week range and make progress at its four-month high proved feeble. This lackluster performance was not particularly surprising given the lack of tangible fundamental grip through the session. For scheduled event risk, an uptick in the NFIB Small Business Optimism survey (to near seven-year highs) and 13-year high from the JOLTS job openings report seem to offer up the headline-grabbing historical relevancy and relate to the market’s primary fundamental concerns. However, these measures are too far from the speculative epicenter to move the masses. For interest rate expectations, shorter duration Treasury yields slipped lower and Fed Funds futures moderated the forecasted pace of tightening. And, on the risk front, the S&P 500 leveled out after its rebound while the VIX volatility index held course just above 14.

The dollar is not as susceptible to mild changes in the fundamental web as it once was. It needs more obvious and forceful motivation – especially when it comes to gains that would necessitate serious changes in prevailing sentiment and interest rate trends. From the upcoming docket, the US event risk fills out with July retail sales, a 10-year Treasury note auction and two Fed speakers (Dudley and Rosengren). Yet, this round is still likely to fall short of critical mass. That said, the potential for heavier swings from the Euro and Pound – primary counterparts – can leverage a ground appetite or distaste for the greenback given the correct motivations.

British Pound Volatility Risk High as BoE Updates Rate Outlook

For volatility risk, the British Pound is the most exposed major through the upcoming session between the July labor statistics and the Bank of England’s (BoE) Quarterly Inflation Report. However, you wouldn’t know it looking at levels of implied (expected) volatility. While, the short-term (one-week) reading of projected volatility for GBPUSD may be at a two-month high at 5.52 percent, it is only barely edged above the July’s range above record lows. This lack of anticipation is appropriate against the backdrop of financial markets that have seen activity levels steadily deteriorate with time; but it also leaves the market unprepared for potentially heavy trading…and perhaps even trend development. The upcoming BoE report is perhaps the most capable fundamental update for shaping what matters most to pound traders: the timing and aggression of the central bank’s return to rate hikes. Timing is not made explicit so ‘concerns’ and forecasts for inflation and growth will act as the measure of speculation. A recent Reuters poll of economists showed a 45 percent probability of a 25bp hike before year’s end.

Euro: Investor Sentiment Collapses, Will Stalled Growth Complete the Picture?

Investor confidence in the Euro-area caved this month according to the ZEW’s survey. The Eurozone’s August reading was more than halved with a reading of 23.7 (previous 48.1) that exaggerates a turn in confidence that had already began to develop around the start of the year. Though it was not an indicator that triggered an immediate and pervasive euro selling, its implications run deep. Investor confidence has been a key factor in the currency’s appreciation from mid-2012 (when the OMT program was introduced). Is the quest for yield exhausted in the Euro? If so, the repatriation can swamp he currency. Ahead, we will test another of the Euro’s major concerns – growth – with Greek 2Q GDP.

Yen Crosses Unscathed by News of Japan’s Worst Economic Slump Since Great Recession

Japan’s economy contracted in the year through the second quarter a painful 6.8 percent. On the face of it, this seems a catastrophic outcome. However, fears temper when we realize the consensus was for a 7.0 percent slump. We evaluate the indicator even more rationally when we realize that this data series experiences wide fluctuations. The 5.2 percent drop in consumer spending for the quarter was the biggest on records going back 20 years. This is a severe impact after the April tax hike. But it is still unlikely to motivate the BoJ to upgrade its QE program.

Australian Dollar Traders Fear Another Wave of Volatility Should Chinese Data Misfire

Interest rate hopes for the Australian dollar was distant and fragile. With the moderate of local data and the RBA’s devotion to an accommodative default stance, hope for this carry currency is quickly fading. However, the real make-or-break for the currency rests not with the Aussie economy’s measures, but rather its largest trade partner – China. This morning, we’ve already seen lending figures for July collapsed as the PBoC tries to rein in a credit bubble. Should Chinese retail sales and production slide as well, Australia’s outlook is going to take a hit.

Emerging Market Benchmarks Tick Higher, Russian Ruble Returns to the Bears

The Emerging Markets’ modestly outperformed the favored benchmark for investor sentiment this past session. Where global equity indexes were modestly underwater, the MSCI Emerging Market ETF closed up 0.1 percent on lukewarm volume while Bloomberg’s EM sovereign bond index leveled off. In the FX ranks, there were gains ground out against the US Dollar by the Korean Won (0.4 percent), Mexican Peso (0.3) and Indian Rupee (0.2). The top story, however, remains the Russian Ruble as blocked aid shipments to Ukraine kept the media focused.

Gold’s Short-Term Breakout Finds No Traction

As expected, the rapidly deteriorating trading range for gold forced a breakout this past session. Yet, also as expected, that break would lead nowhere. Forging such a technical move without a unifying motivator means there is little to no conviction that was ready to follow through on the development. We may have something more to work with in the upcoming session however. If the BoE alters its policy bearings, the Greek GDP data furthers the argument of ECB stimulus or US Fed speakers weigh in on rates; we hit a more tangible gold interest.

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--- Written by: John Kicklighter, Chief Strategist for DailyFX.com

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