Recession alarms have been sounding throughout Europe’s bond markets, indicating that investors are weary of economic growth threats caused by increasingly tight monetary policy. As a result, yield curves across the region have become the most inverted in decades. The euro and pound both fell on this news due to the UK’s inflation print. Now attention has shifted to the European Central Bank’s main conference in Sintra, Portugal. Traders will be in search of the latest rumblings of overworked officials from the ECB, Federal Reserve, Bank of England and other important banks to gain an understanding of how much more they plan to squeeze borrowers. In addition to the officials’ rumblings, the latest euro-area inflation figures and publication of German Ifo will also play key roles in impacting the currency trading markets.
In recessionary environments, selling of higher-yielding currencies, including the pound, typically increase, while those that are viewed as shelter tend to prosper, said Van Luu, global head of currencies at Russell Investments.
Though the prospect of recession may increase demand for UK bonds, negative growth could spell trouble for the pound. Sterling, which initially was the best performer among its G-10 peers this year due to the perception that higher rates would bolster UK assets, could trigger investors to think beyond potential high returns and concentrate on economic fundamentals. If this happens, we can expect risky asset markets to focus on negative growth implications of tighter monetary policy. This would, therefore, put pressure on GBP, despite having higher interest rates.
Investors are running for the safety of the dollar amid recession fears while options traders are becoming bearish on the pound, the consequence may be that the dollar, which is regarded as the world’s safest currency, would be the largest winner. It is hard to see how the dollar would not be supported, according to Fredrik Repton, the senior portfolio manager for global fixed income and currency at Neuberger Berman. Repton extended his position in the dollar against the euro ahead of the weaker than expected European PMI readings, forecasting that the data would intensify recession fears in the euro zone.
This week, the June inflation numbers from the euro area and Germany will be under great scrutiny for the latest cost-of-living trends. The German Ifo figures will provide insights into the nation’s economic health. Furthermore, the EU, Italy and the Netherlands are set to total around €15.5 billion ($16.9 billion) via bond sales next week, as per Citigroup’s report. Also, the Bank of England will sell long-maturity bonds from its quantitative-easing-era holdings.
In these times of uncertainty, the defensive currency would be put up for choice with a 55% possibility of a global recession in the next 12 to 18 months, according to Guillermo Felices, investment strategist at PGIM Limited, who added that the yen would make a good, defensive currency option. The low-yield status of the Japanese yen makes it safe-haven alternative, especially during volatile phases.