UK govt sets a bonfire under its credibility; high real rates point to further stock market weakness

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  • The Bloomberg dollar index had the largest weekly rise since the pandemic upheaval in 2020. The Fed reaffirmed a hawkish message. The FOMC SEP projected 125bp of further hikes this year to 4.4% and 4.6% in 2023. Real yields in major economies are at their high in at least seven years. US 10yr real yields are around their previous peak in 2011. Equities still look expensive relative to higher real yields. We see lower stock prices placing downward pressure on risk-sensitive currencies, including AUD, NZD, CAD and GBP, and many emerging market currencies.


  • GBP overtook JPY as the second weakest G10 currency this year, just behind SEK. Last week, UK GBP 2yr swap rates surged the most on record in data back to 2000. 10yr government yields increased the most on record in data available since 1989. UK assets crashed dramatically as the government unveiled the biggest fiscal stimulus in 50 years. GBP is close enough to parity with the dollar that it may act like a magnet. Few investors will see a reason to try and catch the falling knife, making it hard to predict how far GBP may fall. The BoE may need to jack up rates to stabilise the currency.


  • Japanese intervention triggered a sharp reversal of JPY weakness on Thursday, putting into action toughening rhetoric over recent weeks. MoF Vice Minister of International Affairs Kanda denied that 145 is a line in the sand to defend. He said what matters is volatility. The surge in US yields in recent weeks and the broad strength in the dollar provide fundamental justification for a higher USD/JPY. Until the market sees a peak in US real yields, we should not expect a sustained fall in USD/JPY.


  • Canada yields were surprisingly steady last week, considering the big rise in US yields. Recent Canadian economic data suggests the economic momentum has turned lower, the labour market is easing, and inflation may have peaked. Oil prices have fallen significantly and may also detract from CAD performance.


  • A weak economic outlook and the resumption of a falling trend suggest downside EUR risk. Putin escalated the war, adding to the risk of a prolonged conflict with threatening consequences. PMI data point to a recession underway; CPI data this week is expected to rise further. A far-right party is expected to take power in Italy, threatening stability.


  • CHF has remained above its previous lows since June. It was relatively stable amid the turmoil on Friday and retained its role as a safe haven.