- It is a big week for UK data: monthly fluctuations are hard to predict but, overall, the releases will likely confirm further labour market loosening and falling inflation.
- The BoE has re-priced lower, but this could go further: the UK economy is in dire straits, and the central bank will likely cut rates more than the market expects in 2024.
- GBP/USD should weaken further, with 1.18 being the first level to test.
- Receiving the March 2024 meeting also makes sense.
- A weaker sterling and BoE repricing even lower should allow the recent FTSE 100 outperformance vs European equities to extend.
UK Data Releases: Where Should Markets Focus?
It is a big week for UK data, with employment and wage growth releases on Tuesday and inflation figures on Wednesday. I think the focus should be on:
- Job vacancies for September and regular wage growth in the private sector (August). Unfortunately, we will have to wait until 24 October for the ILO unemployment rate release.
- Core and services CPI for September.
The vacancies-to-unemployment ratio (market tightness) has attracted plenty of BoE attention. As I recently discussed, the ratio is a more accurate measure of tightness in the labour market (relative to the U-rate alone) because it incorporates the economy’s demand for labour. And the latter has been cooling notably, with total vacancies down 24% since their peak in May 2022 and 12.5% over the last six months. Further deceleration will signal increasing labour market loosening.
I argue vacancies could carry a slightly higher weight in the BoE’s reaction function than the wage growth data. Recall that in its latest monetary policy statement, the central bank argued that ‘the recent acceleration in the AWE [is] not apparent in other measures of wages’. Nonetheless, since the last BoE meeting, private wage growth fell slightly to 8.1% (3M-average, YoY) from 8.2%. While monthly fluctuations are notoriously difficult to predict, I still think wage growth will decline materially in coming months, as it is currently very out of sync with labour market tightness.
Regarding inflation, consensus expects core CPI annual growth to fall to 6% (from 6.2%) and services CPI YoY to remain unchanged at 6.8%. The latter has proved quite sticky, but remember, the UK PMI services index has dipped below the breakeven level of 50 since August. Also, service sector companies reported in September their first staffing decline in over two years, while input prices and prices charged continued to ease.
The Market Underestimates the 2024 BoE Easing Cycle
Since mid-August, market pricing of the BoE terminal rate has declined significantly from nearly 6% to 5.33%.
The market is now pricing about 15bps of additional hikes. Moreover, the first 25bps of easing are now priced to happen between the April and August meetings of next year (with a probability of 50% of that happening in August).
I see more downside to BoE expectations, both pricing out any additional rate hike and pricing in a faster monetary policy easing.
- Economic growth is getting a higher weight in the BoE’s interest rate decisions. The bank said in September that it expected GDP to rise only slightly in 3Q 23. However, the downward revision to the monthly GDP figures for July and the meagre growth of 0.1% MoM in August show the UK economy shrank 0.5% in July and August. Moreover, for UK GDP to have been flat in 3Q, it would require activity to have risen 0.5% in September (absent revisions), something unlikely given the market rout and the increase in longer-dated yields. Furthermore, both manufacturing and services PMI (which typically do not get revised) remained in contraction territory.
- The housing market shows no signs of bottoming. The Nationwide house price index fell another 5.3% YoY in September (the same as in August), the steepest decline since July 2009. Previous periods of similar house price declines and BoE policy tightening are impossible to find. And while mortgage rates came off in September, they are still at multi-year highs, with the average fixed rate over 2Y, 3Y and 5Y at 5.65% – three years ago, this was 1.85%. An estimated c. 0.8mn mortgages expire between July and December of this year and an additional 1.6mn in 2024.
- There is value in the central bank standing pat rather than hiking further given the clear downward trajectory in inflation, wage growth and labour market tightness alongside an economy in dire straits. The likely longer lags in monetary policy transmission due to excess savings accumulated during the pandemic reinforce this.
Sell Cable/Sterling, Receive Rates and Position for FTSE 100 Outperformance
If I am right, the market implications seem straightforward:
- I would keep selling GBP/USD. I am less certain about EUR/GBP upside now, mostly due to the sharp rise in NatGas prices that pressures EZ’s ToT. GBP positioning is not stretched, while cable is now very sensitive to yield differentials and risk.
I expect the yield differential to move further in favour of the dollar (largely due to the UK factor), while mounting global recession risks are likely to weigh on risk appetite. The VIX at 19% makes very little sense to me.
Back in early/mid-September, I had also liked shorts in GBP/NOK and GBP/CAD. I would be inclined to take profit on those as macro risks will weigh in high-beta FX and can trigger unpredictable and large moves. Currently, being short GBP/USD for a revisit of the 1.18 level seems the cleanest expression; GBP/CHF also looks very heavy, though may be subject to near-term reversals.
- Receiving the March 2024 BoE meeting looks attractive – currently priced at 5.33%, which I could see retracing lower to 5%.
- Bullish FTSE 100 (in relative terms). UK equities would also benefit from a weaker sterling and monetary policy re-pricing lower. However, this would need to be traded within the context of rising global recession risks. Therefore, I see the recent outperformance of FTSE 100 vs EuroStoxx 50 extending. I have also argued for positioning in favour of FTSE 100 vs FTSE 250. While the odds may still favour the trade, I would also take profit there. Since mid-August, the relative index has risen 10% and now sits at its highest level since 2014.