Outlook: We all want to think about the new currency crisis but we will be getting other information this week that deserves attention. Econoday identifies the EC economic sentiment index on Thursday and eurozone harmonized inflation on Friday.

We started today with Germany’s IFO to be followed by the GfK on Wednesday, CPI on Thursday and retail sales and unemployment on Friday. For the US, we get durables and new home sales tomorrow with the star, PCE prices, on Friday. We also get fresh data from Japan and China.

The Events in the UK and the fallout in bonds and the currency can legitimately be called a crisis, and since the cutting edge is sterling, this is, indeed, a currency crisis. It started with the supply-side policies of new PM Truss and new Chancellor Kwarteng (considered brilliant and not a little weird by The Economist, but also pragmatic). Yesterday Kwarteng spoke of new tax cuts, setting off the sell-off overnight during the Asian session. So far the Chancellor and the Treasury are refusing comment. It didn’t help that today the OECD downgraded its UK forecasts for zero growth in 2023 (after 3.4% this year). The forecast was developed before the putative rate hikes to come. As the FT puts it, the Big Picture is that the giant rise in government borrowing “will goose inflation already running at about 10%, pushing the Bank of England to raise interest rates more aggressively. The government will have to sell a huge volume of bonds to finance the tax cuts, pushing prices down and yields up. Higher borrowing costs will hurt the economy, for example by pushing up mortgage rates and reducing disposable income among consumers.”

More than one analysts points out that supply-side/trickle-down economics did not work in the 1980’s and won’t work now, or at least has zero credibility among economists and traders.

Calls for an emergency meeting by the BoE and a fresh hike (after 50 bp last week) of as much as 100 bp are all over the place. But one analyst notes the BoE has never raised rates between scheduled meetings since it formally gained independence in 1997 and besides, an emergency meeting means, almost by definition, panic. It makes the UK look like an emerging market.

An alternative is, of course, intervention but along with most commentators, we doubt it. For one thing, it’s a waste of reserves if the market has the bit in its teeth, as it clearly does. For another, it’s a symbol of having made a mistake, and no government only a few weeks old wants to do that.

Here’s a point about the currency crisis–those who trade sterling are prone to crises. The 1985 and 1992 crises were obvious in the sense that the government’s policies were not feasible from the get-go, especially putting the pound into the European Rate Mechanism at the level chosen and with only a 2.5% range on either side. We can look forward to a flurry of essays of what happened then and why, but it all boiled down to “policy error.”

Markets can live with some policy error and we do expect prices to move accordingly, as we see in the classic case of Turkey these days. In the UK case, sterling has been sliding on a downward path for some time–and more than one analyst has been wondering if the negative sentiment was not overdone. As we wrote in recent weeks, the UK can afford the new debt, it doesn’t make the country any more vulnerable than many others, etc.

As we sometimes also see in the case of the dollar, traders overreact to bad news that another currency can shake off like a summer shower. Another example: we got a falling euro on the energy crisis, but not a one-time, flash-bang sell-off to historic lows.

Then we find out that the currency crash overnight occurred mostly during 20-minutes of frantic selling–a flash crash. And weirdly, it happened during the Asian session, which is hardly ever the leader. We wish we could find out whodunnit–not likely Japan, which leads only in its own currency, so perhaps Australia and/or Hong Kong and Singapore. For what it’s worth, the panic started at 20:40 pm New York time, or 8:40 pm, which is 10:40 am in Australia.

In any case, it doesn’t take much to generate a flash crash in a thin market. You have to wonder if there are any ulterior motives here, including a simple ploy by one or two big bank traders having some fun. If we were the BoE, we’d be calling up counterparts in Asia and getting them out of bed to find out who was behind the sell-off.

This is not to say sterling doesn’t deserve the sell-off or that the numerous criticisms of the new policies are not worth examining. The currency is in trouble because the new government policies are in so much doubt. They are too aggressive for an economy still fragile from Brexit and Covid. But at the same time, unless sentiment builds and depending on what Truss/Kwarteng do and say, this could turn out to be a flash in the pan. Be very careful.


This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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This morning FX briefing is an information service, not a trading system. All trade recommendations are included in the afternoon report.

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