FX Daily: Burnham’s First Market Wobble

Gilts and the pound faced some volatility yesterday after new UK Prime Minister Andy Burnham signalled some flexibility with the fiscal rules. We still see vulnerabilities for the recently outperforming GBP. Elsewhere, USD has further room to rally from here as the market still appears dangerously complacent about the military escalation in the Gulf

USD: Complacency remains a risk

The FX market is gradually catching up with developments in the Gulf, where tensions still appear to be escalating, and the dollar has found broad-based support. US President Donald Trump has pledged retaliation against Iran following the killing of three US service members in Jordan, while Houthi militants are threatening a blockade of Saudi Arabia in the Red Sea.

Brent has reached $90, still well below the spring highs, but FX markets may now be reacting less to the risk of sharp short-term spikes and more to the prospect of oil prices remaining elevated for longer. The bond sell-off and the spillover into equities reflect that shift.

Dollar risks remain skewed to the upside today as markets continue to display a risky degree of complacency towards the military re-escalation. A move back to 101.50 in DXY looks entirely consistent with the current backdrop.

The US calendar is light today, and the Federal Reserve remains in its pre-meeting blackout period.

EUR: Test of 1.140 looks imminent

EUR/USD may soon retest 1.140. Rate differentials have provided support, but we are not convinced rate expectations for the European Central Bank can move much further from here. Markets are already pricing 44bp of easing by year-end, and the hawkish impulse may start to fade beyond 50bp.

Even at the peak of the spring oil rally, markets never priced the year-end deposit rate above 2.75%. That suggests further oil price gains may increasingly weigh on EUR/USD. If 1.140 breaks, the next key support is 1.1330, the June low.

Today's German July ZEW release is expected to show improvement in both the expectations and current situation components.

GBP: A shaky first day for Burnham and markets

UK Prime Minister Andy Burnham's first day in office brought some market turbulence. 10-year gilts materially underperformed other European bonds after he said he intends to use flexibility within the fiscal rules, triggering a negative, albeit limited, reaction in sterling.

Attention this morning will be on the bond market response to yesterday's post-market surprise appointment of John Healey as Chancellor of the Exchequer. Sterling ignored the headline initially and is recovering this morning, partly helped by some decent jobs market figures. But stabilisation in the bond market is needed for the pound to fully regain its strong momentum.

That said, based on GBP’s muted reaction, Healey is probably not seen as materially different from the previously favoured frontrunner, Shabana Mahmood. In either case, the prevailing expectation is that Burnham will take a leading role in economic policymaking and therefore preferred a loyal appointment over a figure with stronger independent policy views, such as Ed Miliband.

EUR/GBP remains cheap according to our short-term valuation metrics, and the lack of any political/fiscal risk premium – alongside overly aggressive pricing on Bank of England tightening, in our view – argues for upside risks in the pair.

CEE: Risk-off pressure persists despite better local news

Polish data for June pointed to solid economic momentum despite the US-Iran conflict and higher oil prices, while wage and employment figures signalled a balanced labour market supporting disinflation. In the Czech Republic, the Ministry of Finance plans to cut bond issuance after stronger-than-expected demand for the relaunched retail bond programme, allowing a meaningful reduction in Czech government bond supply for the rest of the year.

Still, despite constructive regional news, the US-Iran conflict and oil prices remain the key market drivers. While there were tentative signs of relief, CEE currencies failed to hold their gains and ended yesterday only marginally stronger. Rates markets at least appear to be stabilising after several days of elevated volatility and paying flows.

Czech rates now price more than two Czech National Bank hikes, which looks excessive despite the CNB being the only regional central bank to hike rates in response to the US-Iran conflict. Even so, the hawkish rhetoric is helping stabilise FX and keeping the koruna ahead of CEE peers on risk-off days. We have been bullish on CZK for some time due to the CNB’s hawkish bias. After briefly touching 24.30 last week, EUR/CZK has been grinding lower and should gain further support from CNB board comments ahead of next week’s meeting. Unless the US-Iran conflict escalates materially, EUR/CZK could move below 24.15.

HUF: NBH to stay calm despite FX pressure

The National Bank of Hungary is likely to cut rates by another 25bp to 5.75% today. The central bank restarted its easing cycle in June and committed to further cuts in July and August. A new forecast is due in September, when the NBH should reassess its next steps. While FX and rates have come under significant global pressure, triggering the largest sell-off since the April general elections, the situation likely looks more stable from the central bank’s perspective than from the market’s. June inflation again undershot the NBH’s forecast, and the governor last week described EUR/HUF around 355-360 as stable. Overall, we expect the NBH to maintain its current rhetoric.

The market has already priced out a large share of expected rate cuts after recent pressure on HUF assets, which underperformed not only within CEE but also across emerging markets. In our view, this reflects heavy long positioning rather than a deterioration in the local fundamentals, which remain constructive. As a result, we expect the sell-off to fade at the first signs of global relief. The market now prices slightly more than 75bp of easing, including today’s meeting, and a terminal rate between 4.75% and 5.00%. We expect the policy rate to reach 5.00% this year and 4.00% in 2028. We therefore see room for the market to return to a more dovish stance and for investors to rebuild forint longs, depending on the global backdrop.