Amber traffic light

04 Oct 2021

Wild FX markets get an “amber warning”

Demitri Theodosiou

Demitri Theodosiou

Head of FX and Interest Rates Trading

The dollar has surged on the back of safe-haven demand and a more hawkish Federal Reserve. Our Head of FX and Interest Rates Trading, Demitri Theodosiou, examines the impact on the pound and the outlook for currency markets.

With the return of school, my six-year-old son has just started football club on Saturday mornings for the first time. The children are put through their paces with some low-level skills drills to try and teach them some basic concepts whilst they protest that they only want to play a game. I particularly enjoyed the young boy who kept getting confused and picking the ball up. I think we all feel like doing that and going home some days.

So, on to the game - there is nothing quite like the sight of a herd of young boys and girls swarming all over the ball, legs swinging wildly. All thoughts of playing their position go out the window as they all group around the ball like a magnet. The whistle blows and the coach yells "amber warning" to remind the children to try and find a bit of space. I can't help but drop in as a proud dad that my son scored a lovely goal after some blistering pace (yes, I feel sorry for the other parents as well).

As we turn to markets, it's hard not to have noticed the huge US dollar surge. What began as some safe-haven dollar buying, fueled by concern about contagion stemming from the Evergrande debt crisis, soon turned into greenback strength as a more hawkish tone from the Federal Reserve brought forward expectations of tapering and interest rate rises. It ended with many currencies falling to new multi-month lows against the dollar. And on the horizon are more risk-aversion threats. For example, even though an immediate US government shutdown was averted a few hours before it would have begun, the US is a few weeks from reaching its debt ceiling, which risks a default scenario unless addressed urgently before that.

BOE Governor Andrew Bailey highlighted a potential need for UK rate rises due to inflationary pressures from supply chain disruptions that could carry on for months, which themselves may hold back the UK economic recovery.

Meanwhile, the pound has particularly suffered against the US dollar during this time after Bank of England Governor Bailey stoked "stagflation" concerns. BOE Governor Andrew Bailey highlighted a potential need for UK rate rises due to inflationary pressures from supply chain disruptions that could carry on for months, which themselves may hold back the UK economic recovery – a struggle that may well go and be exacerbated by an increase in interest rates. As Andrew Bailey said, "monetary policy will not increase the supply of semi-conductor chips… it will not increase the amount of wind, and nor will it produce more HGV [heavy goods vehicle] drivers. Moreover, tightening monetary policy could make things worse in this situation by putting more downward pressure on a weakening recovery of the economy."

So a perfect storm of US dollar safe-haven buying across the board, coupled with a sticky period for the pound, caused the pair to break below the key 1.36 support that had been holding for most of the year. The pair dropped rapidly, with market participants swarming all over the ball like a bunch of six-year-olds, thrashing their legs wildly. With the heightened focus that comes on key levels breaking, it becomes hard not to think the worst when we're in the eye of the storm. But as we blow our whistle and hear the cry of "amber warning", we need to remember to take a step back and assess the broader picture. The Office for National Statistics has just revised up UK growth in the second quarter from an initial +4.8% estimate to +5.5%. With the end of the furlough scheme, some potential staff availabilities may come that could ease some of the labour market shortages that are adding to pressures. And if history tells us anything, the US tends to make an 11th-hour agreement to raise the country's debt ceiling and ease concerns that are being priced in. Only time will tell whether we find some support at these stretched levels or if market participants ignore the coach's whistle and keep following the ball.

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