FX Daily: Another Tough Day For Sterling

We estimate that a c.3% risk premium is currently built into the pound, which lags the 5% risk premium seen in June, and in August 2019 - two times when the risk of a no-deal Brexit was lower than it is now.

USD: FOMC meeting ahead, but not many fireworks expected

The key event of the week is the FOMC meeting (Wednesday). While the central bank may seek to operationalise its new average inflation targeting approach with some additional forward guidance, the soft Fed policy looks largely priced in following Chair Jerome Powell’s Jackson Hole speech, meaning that more positive news is needed to push cyclical currencies higher and the dollar lower. With fragile equity markets and risk sentiment, it is unlikely to happen this week, in our view. This suggests a range-bound DXY this week (see FX Week Ahead for more details).

EUR: No forceful comments against euro strength

European Central Bank President Christine Lagarde broadly reiterated the message from the latest central bank meeting over the weekend. While not directly pointing at the recent euro strength, she noted that the ECB stands ready to adjust all its instruments to reach the inflation target. Such a tone does not represent a forceful attempt to tame the recent euro strength. As we noted previously, given the already very stretched accommodative ECB stance (negative rates, large asset purchases) it will be difficult for the ECB to tame the euro. We look for range bound EUR/USD this week, but see EUR/USD moving to or above 1.25 next year. (FXE, UUP, UDN)

GBP: It will get worse....

We expect the pressure on sterling to continue building this week as not enough risk premia is priced into the currency relative to the urgency of the situation. We estimate that a c.3% risk premium is currently built into GBP, which lags the 5% risk premium observed in June and in August 2019 - the two occasions during which the risk of no-deal Brexit was lower than it is now. This, in our view, warrants a further adjustment in GBP lower. With the Internal Market Bill being debated in Parliament today, the accompanying negative headline news (and its impact on UK-EU trade negotiations prospects) should facilitate further GBP weakness. We expect GBP/USD to head towards 1.2500 and EUR/GBP to 0.9500 this week. (FXB)

JPY: Waiting for the new LDP leader

The vote for a new LDP leader in Japan is underway with Yoshihide Suga widely expected to win the contest and become the new Prime Minister. As he already hinted at a continuation of PM Abe’s policies, there should limited impact on the Japanese yen. Given that we expect cyclical assets to be subject to a little more correction, we are modestly bearish on USD/JPY this week. (FXY)