It is clear that the momentum we saw at the start of the week has well and truly faded. Price action over the past day and a half has been somewhat directionless, with no significant macro news to move the markets. Investors are wary of the major central bank meetings coming up next week and are unwilling to have too much exposure ahead of those.
Stocks lose momentum ahead of central bank bonanza
With concerns about the ability of Omicron to cause serious illness still unproven, investors are likely to remain cautious when it comes to risk-taking. As we saw before, this should limit the upside for equities – and it has. After all, the spread of the disease is putting significant pressure again on health systems around the world, meaning more growth-chocking restrictions and lockdowns might be required. So far, however, the market seems to think that it will just be mild restrictions, which will cause minimal damage to the economy, and in any case calls for a pause in rate hikes or faster tapering. Consequently, dips to support are still likely to be bought. So, we may see further side-ways chop until those central bank meetings next week.
Pounded by Plan B
As well as the Fed and ECB, the BoE’s policy decision next week should be interesting. The market seems to be pricing out the probability of a hike by the BoE, amid the latest Covid restrictions under the “Covid Plan B” strategy being implemented here in the UK. This explains why the pound has struggled recently. The No. 10 party row is also weighing on sentiment, with Labour calling for Boris Johnson to resign if the prime minister is found to have misled MPs about the three parties that took place last year, which are being investigated for Covid rule breaches.
But the pound’s weakness is more to do with worries about the economic impact of the steps the government has taken to stem the spread of omicron, even though there’s growing optimism that the variant is not as bad as first feared. That being said, although vaccine makers have provided us with some good news in recent days, the World Health Organisation (WHO) will likely wait until a couple of weeks for some detailed findings before providing its view. Once we hear from the WHO then the UK, and governments elsewhere, will probably respond appropriately.
But for as long as restrictions remain in place, this should weigh moderately on economic activity – and rate hike expectations. Some analysts, such as those at Goldman Sachs, now think that the BoE will delay its first rate hike to February.
Therefore, if the pound managed to halt its decline, its best bet would be against currencies where the central bank is less hawkish than the BoE. But as far as the cable is concerned, the path of least resistance remains to the downside:
Source: ThinkMarkets and TradingView.com
With the GBP/USD making lower lows and lower highs, the bears are in full control after driving rates below the highs of 2020 and 2019 previously, as shown on the chart. The 21-day exponential moving average is below the 200-day simple moving average. Both averages have negative slopes and are above current prices. So, there is now question about the trend direction, which objectively bearish. A run down to the next psychological level at 1.30 looks increasingly likely.
The only caveat is that rates have become quite oversold, and we may see some profit-taking ahead of the central bank bonanza next week, as well as US CPI on Friday. Still, for the bearish trend to end, the BoE will either have to surprise the market with a rate hike or come across as very hawkish at its meeting next week.