GBP/USD is holding up despite the risk-off markets and Brexit tail risks
- GBP/USD CPI is keeping the pound in demand.
- Markets focused on UK's and US's 10-2 year yield inversion.
GBP/USD is holding up despite the risk-off markets with earnings and inflation moving higher making the short-term case for the pound compelling. July inflation was stronger than expected, with headline CPI at 2.1% YoY (mkt 1.9% and BoE at 1.8% in the Aug IR), and core CPI at 1.9% YoY (mkt 1.8%).
The pound would be even more compelling, even on a medium-term outlook, if it were not for the hard-Brexit tail risks which the markets have priced in and a flight to the Greenback playing out its role as a safe-haven again. The US Dollar is up despite the drop in the 30-year yield to a record low, 10-year yields -7% as well as 10 and 2-year yield inversion for the first time since 2007. However, what should be understood by cable traders is the fact that a yield curve inversion is usually seen as a precursor to recession and money markets continue to point to a BoE rate cut next year.
The pound is much weaker down here in the 1.20s to where it was at the start of the year, some 10% down from the Feb highs near to 1.34. The UK is flirting with a hard Brexit which will only go towards higher headline inflation due to an even weaker currency which makes for the BoE's worst fear.
Nearer term, and what will remain as the key driver will be Brexit. News flows will be full of general election headlines and a no-confidence vote in Boris Johson in the lead up to the 31st October Brexit date, so we can expect a choppy ride from here on - The bulls will bet on another Brexit delay beyond October which would be supportive of the pound, but a far cry from a full-on rescue package landing at their doorstep and rallies will likely be met with plenty of pessimistic bears.
Markets in a twist over the 10-2 year yield inversion
As for the US, the market is fixated on the 10-2 year yield inversion today but it should be noted that there has been a gap of 10 months to three years between the indicator occurring and the previous recessions in the US and so long as the US is seen as safer bet under the hood, the money flows should remain supportive of the Dollar. When comparing the US economy to that of Germany and above all, China, and taking into account the offshore debt liabilities priced in the Dollar and the shortfalls ratios, in a financial crisis, just as we have seen in 2007-2009, a scramble to the mightly greenback is what we get. So long a the Federal Reserve is not forced to continue cutting rates too low, GBP/USD can be expected to continue on its southerly trajectory.