August lived up to its reputation as one of the quieter months for FX markets, but sterling took things to another level with GBP volatility hitting a multi-year low. September looks likely to shake things up and bring FX markets back to life though.
The dominant story across global markets remains the broad sell-off in government bonds, which has sent yields to multi-year highs as investors worry over rising deficits, AI-related borrowing, and the ongoing Iran conflict which has pushed oil back above $90 a barrel again.
The USD has recovered some ground over the past week following hawkish remarks from Fed Chair Warsh at the Jackson Hole symposium. While acknowledging that recent US inflation data had been better than expected, Warsh was clear that the Fed still had "work to do" if it wasn't confident inflation was heading back to target fast enough. This led to some sharp repricing of market rate hike expectations with odds of a Fed September rate hike going from fairly unlikely to essentially the base case scenario (circa two-thirds). Whether the data backs that up between now and the meeting will be the key question for the USD in the weeks ahead.
From a Sterling perspective, there was little in the way of market-moving data but, from the figures we did receive, it continued to signal that the UK economy is holding up better than many expected, even as the jobs market softens and borrowing costs rise. The bigger concern is the ongoing gilt sell-off, with 10-year yields surging to an 18-year high above 5.2%. That rise directly erodes the government's fiscal headroom and raises the prospect of tax hikes at the Autumn Budget, even before accounting for any additional spending Andy Burnham may want to pursue. Although his government has committed to sticking to the fiscal rules, the market will be watching closely to see whether surging gilt yields make that promise increasingly difficult to keep.
The Euro had a brief surge higher during the second half of August following a surprise expansion of US Treasury buyback operations. A September ECB rate hike now seems almost guaranteed after Eurozone inflation jumped to 3.3% in August. However, with core inflation still stuck at 2.4%, which is barely above target and exactly where it was when the Iran war began, markets may be getting ahead of themselves in pricing in further hikes beyond September, which could therefore limit how much further the euro can rally.
As a result, the GBP/USD has lost around 1.1% in the last week and currently trades close to a 3-week low. The GBP/EUR has been trading within a very tight range over the past month and currently sits towards the lower end of this range and close to the lower end of where its travelled since the start of July. The EUR/USD currently trades around a 2-week low having edged around 1% lower from last week’s high.
