Mixed bag of UK labour market data knocks GBP

Today’s focus is obviously the Federal Reserve and the Dutch elections, however, this morning the UK labour market data is in focus. It was a […]

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By :  ,  Financial Analyst

Today’s focus is obviously the Federal Reserve and the Dutch elections, however, this morning the UK labour market data is in focus. It was a mixed bag at the start of this year, with stronger job creation in the three months to January, a drop in the unemployment rate to 4.7%, a fall in the claimant count rate, and a fall in wage growth. The wage growth element is key for the Bank of England as weaker wage growth, which increased by only 2.2% YoY in January, could reduce pressures on the BOE to raise interest rates.

Stocks upbeat heading into the Fed

The pound was the best performer in the G10 this morning, but has slipped since the wage data, key support lies at 1.2150 – the overnight low. Where the pound goes next could depend on the outcome of today’s US CPI data and the Federal Reserve meeting tonight. Interestingly, global stock markets don’t appear to be expecting a negative shock from the Federal Reserve tonight, with European markets higher and US equity futures pointing to a stronger open later today.

Yields suggest that pound is still vulnerable

The recent pick-up in the pound corresponds with a mini recovery in the UK-US 10-year yield spread and less to do with what is going on in the political background in the UK. It is worth noting that this spread is still close to a record low, and even the recent recovery doesn’t change the fact that the UK-US yield spread is pound negative, for now. Whether or not it stays this way will be dependent on the Federal Reserve and what the dot plot says.

March rate hike will happen, but what comes next…

Regarding the Fed meeting, a rate hike is priced in, and in our view, hell would have to freeze over before the Fed disappoints the market and fails to hike. This means that the real focus is on what comes next. The market currently has a 50% chance of a rate hike in June priced in, but it is also worth looking further out the curve, there is a 20% chance that rates could rise to 1.75% by the end of this year. If markets reduce the chance of this happening by year-end then we could see equities rally and the dollar and US Treasury yields falter, while if they increase the chance of its happening then stock markets could get spooked, and volatility may rise.

As we mentioned earlier this week, the markets believe that it is in-synch with the Federal Reserve right now; hence even though the Vix index picked up on Tuesday, it is still at a low level and is retreating early on Wednesday.  If the market has under-estimated the Fed’s desire to tighten interest rates this year then we could see a serious jump in volatility and a decline in equities.

Dutch election impact on euro and French bond yield

The euro is rallying in to the Dutch election results, exit polls will be released at 2000 GMT. Euro strength is also a function of dollar weakness and the recent run-up in German bond yields, which are backing away from 0.5% today, but are still close to their highest level since late 2015. As we mentioned in our Dutch election preview, any big gains for the Far-Right PVV party could stoke fears that Marine Le Pen will win the French Presidential election in May. Thus, the outcome of the Dutch election could have a big impact on the French bond yield, which is retreating on Wednesday as the market assumes that Wilders’ PVV’s chances of victory tonight are slim.

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