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Market Briefing: Cable Snaps, Destabilizing Currency Markets

The pound sank like a dinghy in the North Atlantic over the weekend, hitting record lows against the greenback and contributing to a worsening in sentiment across the global financial system. In several interviews, Chancellor of the Exchequer Kwasi Kwarteng seemed to shrug off Friday’s devastating market reaction to the new UK government’s proposed fiscal plans and doubled down on tax cuts, saying there was “more to come”. The sterling-dollar pair — often known as the “cable” — briefly dropped almost 4.7 percent before staging a modest recovery as traders positioned for a response from the central bank.

Calls for an emergency rate increase from the Bank of England are growing louder. As we went to pixels, markets were expecting a 75 basis point hike within the next week, with rates climbing to 6 percent by May, up sharply from today’s 2.25 percent. The pound is oscillating wildly as momentum indicators point toward a move through parity while interest differentials support a slight rebound.

In our opinion, substantially-tighter policy settings might inflict further damage on the British economy without sufficiently offsetting pressure on the exchange rate. We expect Governor Bailey to make an announcement in the coming hours, confirming growing alarm among policymakers and putting the bank on a more hawkish footing – but without committing to higher rates. Market disappointment might open up further downside in the currency.

Global risk assets are on the defensive, with oil prices, equities, and economically-sensitive currency pairs broadly trading in negative territory. The greenback continues to strengthen.

The gap between German and Italian yields hit a three-week high, up sharply from Mario Draghi’s time at the helm after Giorgia Meloni’s Brothers of Italy won a decisive victory in the country’s snap election, making it likely to form the first government led by the far-right since Mussolini’s time. Meloni has cast herself as a relative moderate on economic issues, but markets remain nervous about how her administration will balance a fractious relationship with the European Union against slowing growth, rising debt, and uncontrolled inflation rates in Italy. Traders will be monitoring closely as the appointment of a new finance minister is announced, with optimists hoping for a relatively technocratic candidate like Fabio Panetta or Domenico Siniscalco.

The People’s Bank of China raised deposit requirements for foreign exchange forwards, making it more expensive to bet against the renminbi. The central bank lifted the risk reserve requirement on forwards from zero to 20 percent, but failed to reverse a fall in the currency – it slipped another 0.4 percent overnight, and is down roughly 10.8 percent on a year-to-date basis as the dollar’s surge continues.

There are no high-profile economic data releases scheduled for the North American trading day.

Market participants think the Fed’s preferred inflation measure — the core personal consumption expenditures price index — will rise in August from July’s 4.6-percent annualized pace. Data out on Friday is expected to show shelter and services costs kept climbing even as headline price growth cooled, keeping the Fed on track to continue raising rates in an aggressive manner.

Karl Schamotta, Chief Market Strategist

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