Payrolls prep and the pound’s big week

Politics was the main driver of markets this week: The UK Budget, China’s National People’s Congress, Super Tuesday, the Powell testimony to Congress and the State of the Union address by President Biden. When politics dominates markets can do strange things, just think back to the Liz Truss government in 2022. However, this week has gone off without much of a hitch. Stock markets have had a relatively strong second half of the week, the Vix has stabilized after threatening to pop higher, and is well within its recent low range, and global sovereign bond yields are lower. This is a year full of election risk, yet for now markets remain calm.

The low volatility in stocks and bond markets is largely a result of central bankers. The Fed and the ECB both signaled that rates will be cut once inflation shows signs of falling once more. Jerome Powell and Christine Lagarde may have refrained from spilling the beans on the timing of a rate cut, but the markets are now more certain that there won’t be a rate increase this year. After January CPI ticked higher, the markets started to get nervy that maybe there won’t be rate cuts this year, after all. That fear has now been put on the back burner, even if the timing and magnitude of rate cuts is still data dependent.

From a markets perspective this means a couple of things: the stock market rally can continue (depending on payrolls – see more below) and there is a changing of the guard in the FX space. The dollar is the weakest currency in the G10 FX space this week and has lost nearly 2% vs the Aussie dollar and the JPY, with smaller gains for the pound and the euro vs. the greenback. The Pound is set to record its best weekly performance vs the dollar for a year. GBP/USD is higher by 1.01%, after the OBR upgraded UK growth forecasts. The FX market is highly correlated to politics, in our view, and the fact that the pound has risen, and bond yields have fallen in a Budget week is a sign of how far we have moved on from the ill-fated Truss era. Dare I say it, the pound’s rally is also a sign of confidence in the UK, after a fairly dismal few years. The fact that the dollar is losing ground is a sign of investor confidence more broadly, which is a positive development for risk sentiment more broadly.

The yen is rising as speculation mounts that the BOJ will buck the global central bank trend and hike interest rates later this month. In the short term, a powerful downtrend seems to be building for USD/JPY, and we believe that this pair could test 145.00, especially if we see a moderation in US payrolls growth later today. The yen has had a negative correlation with Japanese stocks for most of this year, however, this week, both the Nikkei and the yen have risen together. As the end of negative interest rates looks to be coming to an end, the relationship between the yen and the Nikkei might change, and there could be further upside for Japanese stocks, even if the yen increases.

GBP outlook less clear

For GBP, the immediate outlook is a little less clear. 1-month volatility skew in the options market 9is slightly positive, indicating a slight upward bias for the pound in the coming weeks, but it is not particularly significant. This could change if we see a weaker than expected US payrolls report, or if the US CPI due next week is also weaker than expectations.

Payrolls: what to expect

The market is expecting a 200k increase in payrolls for last month, the unemployment rate is expected to remain steady at 3.7%, and average hourly earnings are expected to moderate and rise 0.2% on the month, down from a 0.6% rate in January, and the annual rate is expected to moderate to 2.4% from 4.5%. This data is worth watching. If the data comes in line with expectations, or below forecasts, this would be seen as a positive development with the potential for Treasury yields to fall (bond prices to rally) and stocks to continue to rally, and the dollar to fall. If there is an upside surprise, then risk sentiment may falter. Overall, we expect markets to remain fairly quiet in the lead up to the payrolls report. We don’t expect the final reading of Q1 GDP for the currency bloc to have too much of an effect on the markets.