GBP/USD bulls hold in there as Evergrande contagion risk abates

• GBP/USD bulls step in as Evergrande risk aversion abates. 
• US stock market is back in the green. All eyes now turn to the Fed and BoE

GBP/USD is currently trading at 1.3655 and around flat for the day having travelled between 1.3641 and 1.3693. The price holds near four-week lows on Tuesday while traders await the outcomes of both the Bank of England and the Federal Reserve meetings this week. Broader risk sentiment remained under pressure due to Chinese property company Evergrande's debt troubles and the prospects for the Fed's taper before the end of the year. 

GBP/USD is off Monday's low of $1.364 - its weakest level since Aug. 23. The British currency has received some support from a record $137 billion demand for its first "green" government bond amounting to $10 billion. However, the mood remains cautious about potential economic repercussions from Evergrande's debt problems as well as the Delta covid spread. 

Evergrande contagion risks abate

GBP has been regarded as a risk-correlated currency due to the UK's twin deficits, so what happens in global equities indirectly impacts the value of the pound, especially vs the US dollar which is negatively correlated to risk appetite. In this regard, stocks advanced in choppy midday trading on Tuesday after most Asian markets closed higher as beleaguered Chinese real-estate firm Evergrande edged closer to its debt payment deadline on Thursday.

At the time of writing, the Dow Jones Industrial Average is up by 0.16%  with S&P 500 up by 0.13% and Nasdaq higher by 0.24%. All three indexes traded lower earlier in the session. Ironically, real estate was the biggest gainer, with all but one sector in the green. 

All eyes have been on Evergrande, which sent Wall Street in its biggest decline since May on Monday as a knee-jerk reaction to the news moving to the front pages of the weekend media. The company is scheduled to make a debt repayment in connection with its $300 billion of borrowings which it may not be able to meet. This sent the Hang Seng in Hong Kong lower by 3.3% on Monday when concern mounted over the contagion effect of the potential collapse of the indebted company. However, both the Hang Seng and Shanghai Composite closed higher on Tuesday as investors grew more confident that contagion from the distress of Evergrande would be limited. 

“From our perspective, we … do not see any potential fundamental long-term effects on our portfolio companies,” said one London-based hedge fund professional, according to Reuters. However, “there could likely be a lot of volatility around this one in the short term.”

Meanwhile, S&P Global Ratings said in a report on Monday it does not expect Beijing to provide any direct support to Evergrande. "We believe Beijing would only be compelled to step in if there is a far-reaching contagion causing multiple major developers to fail and posing systemic risks to the economy," the rating agency said. "Evergrande failing alone would unlikely result in such a scenario," S&P said.

Fed two-day meeting underway

Moving over to the next risks in theme, the Federal Open Market Committee has started its two-day meeting today. This will conclude on Wednesday with a statement followed by a press conference where the Fed's chairman, Jerome Powell, will be open to questions around timings of tapering and China risks. 

''We do not believe that what’s going on in China will impact the Fed’s deliberations at all,'' analysts at Browth Brother Harriman said in relation to the Evergrande risks. 

''No change in policy is expected but we expect a hawkish hold as the official statement and the minutes should continue to lay the groundwork for tapering this year,'' the analysts added in a note, concluding with the following:

''The Fed is likely to wait until the November 2-3 meeting to make an official tapering announcement, with a likely start in December.  August building permits (-1.8% m/m expected) and housing starts (1.0% m/m expected) will be reported today, along with Q2 current account data (-$191 bln expected).''

Tempered hawkish BoE expectations 

The pound had come under pressure at the start of the week due to weak data of late that has been tempering hawkish BoE expectations ahead of Thursday's monetary policy meeting.

Though no rate hikes are expected from the BoE until early 2022, investors had begun pricing in an end to the bank's pandemic-era stimulus and have sought commentary on policy tightening. However, there are many uncertainties around the development of inflation, low wage growth, weak Retail Sales and the pandemic, not to mention a possible Brexit fallout, enough to keep the BoE firmly on guard and leaning to the dovish side.

However, the pound could find support if a narrow majority of MPC members now think the conditions for tightening to begin have been met.  MPC member Michael Saunders and his hawkish vote will likely get the usual attention. However, should the Old Lady simply reiterate its plan for 'modest tightening' over the next few years, then the pound is going to struggle in a cautionary environment in broader financial markets. With that being said, much will depend on the Fed a day earlier and the subsequent trajectory of the US dollar.