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Fundamental Morning Wrap: Sterling hammered with further downside ahead

A morning review across institutional research understandably notes that GBP is in sharp focus following the Friday downgrade. However, the general consensus is that the move has already largely been priced in a long time ago and and any sharp reactions are merely knee jerks. They see further downside ahead, with 1.40 being touted as an area representing more fair value for the pair. Looking to Japan, news that Kuroda may be appointed Governor of the BoJ has generated headlines, but not price volatility. In Europe, markets are watching for results from the Italian election.

GBP/USD

Marc Chandler of Brown Brothers Harriman notes that the be all and end all of Friday´s UK debt downgrade is that nothing has changed and the move is more a theoretical reflection of economic interpretations and in a real term sense, very little has drastically changed to trigger the downgrade. Jim Reid of Deutsche Bank notes that following the UK downgrade, only Germany and Canada have a AAA rating, so losing that status should not in itself cause any sizable funding issues or significant yield changes.

David Bloom of HSBC notes questions “How low could GBP fall?” He notes that while the recent fall has been sharp, GBP/USD is still considered to be slightly overvalued and a long way from being “cheap”. He writes, “There seems little prospect of official resistance to further weakness given the fiscal austerity and the limited room for manoeuvre on monetary policy – so further weakness may even be welcomed. A further 6% fall from here would see us return to the 2009 low in the trade-weighted GBP and this can not be ruled out. Nevertheless our more moderate downward revision is set out in the table below.”

James Knightley of ING feels that the downgrade has been no disaster for the UK despite knee jerk perceptions and feels that as seen with France and the US there may be mixed macro implications. He adds that with further QE expected, a downgrade and concern over Scottish and EU referendums, Sterling could continue to devalue, and he has 1.48 as a target which would improve competitiveness and help to rebalance the economy. However imported inflation may be a risk, but either way he writes, “monetary policy will remain ultraloose for a very long time.”

Kit Juckes of SocGen feels that the only damage that has been done has been to the UK Chancellors reputation and he recommends that investors buy the fact of downgrade and then sell the consequential bounce. He believes that GBP/USD could reach 1.40 before finding strong support and so he feels that relief rallies offer opportunities to go short.

USD/JPY

Jim Reid of Deutsche Bank notes that JPY reach a near 3 year low of 94.77 against the dollar amidst reports that Japanese PM Abe will nominate suspected dove Kurodo, Head of the ADB, as the next BoJ Governor. He writes, “The current administration still needs approval from opposition parties but the Mainichi newspaper today reported that the DPJ has signalled that it wouldn’t oppose Kuroda.

Tim Condon of ING reiterates these reports, and adds that USD/JPY will stop appreciating when a consensus view emerges about where nominal GDP growth will settle under the BoJ new policies. He can see the pair hitting 100 by year end and he expects contagion to hit South korea and Taiwan.

Kit Juckes of SocGen comments that following the appointment reports, despite a spike in Asian trading overnight, USD/JPY hasn't yet really broken higher, and needs to end today above 94.50 to trigger more durable yen selling. He writes, “The short-term risk is that Friday's close below 93.50 is a magnet. These are tactical considerations however -our end-year 100 target remains unchanged.”

EUR/USD

Looking at the Italian elections this weekend, Jim Reid of Deutsche Bank notes that the the first day of voting has seen some 54% of voters cast their ballots, a sharp fall on the 62.5% seen at the same stage in the last election in 2008, according to Reuters who cite interior ministry data. Further, they also report that there has been a surge in protest votes being cast too. Further, extreme weather conditions in the South may have also contributed to the lower turnout numbers. He notes that there is a suspicion that comedian Mr Grillo may benefit from these considerations, due to the younger demographics of his followers who will be more determined to vote, despite conditions.

Kit Juckes of SocGen notes that Italian exit polls will appear in mid-afternoon local time and the risk for the market is of an inconclusive result as the 5-Star protest party has gained late momentum. He writes, “Last week EUR/USD broke below its uptrend from last summer (this trendline is now at 1.3250) and if it doesn't close above that the risk must be of a fresh test of 1.30, January's low.”

Macro

Jim Reid of Deutsche Bank notes that Chinese HSBC PMI came in surprisingly lower at 50.4 against expectations of 52.2 and a previous reading of 52.3. He notes that the exports subindex reversed January´s gain and is now back below 50. He comments that Asian cash spreads are firmer along with the broader positive tone in markets.

This is supported by Nomura economist Zhiwei Zhang who notes that the results were a surprise and he now suspects that China‟s leaders will wait for the batch of January/February macro data combined (to be released on 9 March) before making an assessment of economic conditions and deciding and appropriate policy stance.

Elsewhere, the ING economics team note that the countdown to the sequestration starts on Friday, absent a last minute deal, which they feel looks increasingly unlikely.

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