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  1. Trending: Pound and U.S. Dollar Continue on Divergent Paths, Natural Gas Climbs Higher
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Trending: Pound and U.S. Dollar Continue on Divergent Paths, Natural Gas Climbs Higher

Sam BourgiOct 13, 2016
2016-10-13

The British pound and U.S. dollar diverged sharply this week, as talks of geopolitics and monetary policy weighed on the currency markets. The British pound fell to fresh 31-year lows against a resurgent U.S. dollar, which in turn reached seven-month highs on stronger domestic economic cues. The prospect of an imminent rate hike from the Federal Reserve also contributed to broad selling pressure in the government bond market.

Bubble chart ETF trends

Talk of “Hard Brexit” Decimates British Pound

The British pound was in the spotlight for all the wrong reasons this week. Its viewership spiked 264%, in the wake of a nearly unprecedented selloff triggered by fears of a “hard Brexit.” Earlier this month, British Prime Minister Theresa May announced that her government would seek a swift break from the European Union. The British leader also said the UK would formally notify Brussels of its intent to leave the EU by the end of March or early April.

“Let me be clear: We are not leaving the European Union only to give up control of immigration again,” May said in prepared remarks October 2. “We are going to be a fully independent, sovereign country – a country that is no longer part of a political union with supranational institutions that can override national parliaments and courts.”

The British pound plunged nearly 6% against the U.S. dollar this week, reaching its lowest level in more than three decades.

The iPath GBP/USD Exchange Rate ETN (GBB C+), which allows investors to bet on the performance of the British pound relative to its U.S. counterpart, declined 4.8% this week, reaching its lowest level since a temporary plunge in December 2014.


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British Pound Chart

Rate-Hike Bets Send U.S. Dollar to Seven-Month High

With the market’s focus squarely on the Federal Reserve, it comes as no surprise that traffic for the U.S. dollar picked up 48% this week – the U.S. dollar advanced nearly 2% against a basket of other major currencies, reaching the highest level in seven months. The PowerShares DB U.S. Dollar Index Bullish Fund (UUP B) rose by a similar amount to reach its highest level since early February. In the process, the UUP pared its year-to-date loss down to just 1.3%.

PowerShares DB U.S. Dollar Index Bullish Fund

The dollar’s latest rally has been driven by upbeat economic data and growing expectations for an imminent rate hike by the Fed. Those expectations were vindicated Wednesday after the minutes of the September FOMC meetings showed several officials were in favor of raising rates “relatively soon.” By the end of Wednesday’s session, Fed Funds Futures implied a nearly 70% chance of a rate hike at the December FOMC meeting.

Hawkish Fed, Surging Dollar Trigger Panic Selling in the Gold Markets

Gold’s inverse relationship with the U.S. dollar was on full display this week, with the yellow metal’s viewership rising 36% to take the third spot on our list. Gold for December delivery – the most actively traded futures contract – settled at $1,256.50 a troy ounce Wednesday. For the week, the contract was down nearly 1%, having reached its lowest level in four months.

The SPDR Gold Shares ETF (GLD A-) settled at a four-month low of $119.74 on Wednesday.

SPDR Gold Shares ETF

U.S. rate-hike bets have been the main catalyst behind gold’s precipitous drop over the past two weeks. As a non-yielding asset, gold’s value declines as interest rates rise, making the U.S. dollar a much more attractive investment under these conditions. A stronger dollar is also seen as bearish for greenback-denominated commodities, because it makes them more expensive for foreign investors.

Natural Gas Prices Approach Two-Year High as Oil Drilling Cools Down

For all the talk of OPEC, natural gas has been on a tear for the past six months. Its traffic rose 29% this week, as prices reached their highest level in almost two years. The combination of positive demand drivers and reduced drilling activity continues to propel natural gas prices forward. The November futures price reached a fresh 22-month high of $3.28 on October 10. Analysts are betting on robust winter heating demand to lead to even higher prices in the short term. Drilling activity is also expected to remain weak, as the number of working rigs in the U.S. remains below 100.

The VelocityShares 3x Long Natural Gas ETN (UGAZ C+), which is designed to capitalize on a bullish outlook on the energy sector, spiked 19% this week.

VelocityShares 3x Long Natural Gas ETN

U.S. Government Bonds Face Continued Selling Pressure

With a 28% increase in traffic, government bonds take fifth place on our weekly list. Bond yields are on the rise this month, as investors continue to reduce their bond holdings, due to growing expectations that the Fed will hike interest rates by year-end. Concerns that central banks in Europe and Japan have reached their policy limits have also sent bond yields rising throughout the advanced industrialized world.

The iShares 1-3 Year Treasury Bond ETF (IEF B+) declined 0.4% in the week ending Wednesday. IEF is down 1.4% this month.

iShares 1-3 Year Treasury Bond ETF

The bond market is highly sensitive to central bank policy, which could spell trouble for bondholders trying to navigate an increasingly complex global economy. The Fed and its counterparts in Europe and Japan are on clearly divergent paths. That policy divergence could have major implications on bonds.

The Bottom Line

Central banks and geopolitics continue to wield tremendous influence on the financial markets. This will continue in the fourth quarter as investors digest a U.S. presidential election, two Federal Reserve meetings and a formal OPEC gathering in Vienna next month. A deluge of economic data, from now until the end of the year, will also shape the currency and commodity markets, giving investors clues about the health and stability of the global economy. The International Monetary Fund (IMF) recently maintained its 2016 global growth forecast at 3.1%, after four downward revisions. However, the international lending institution did lower its outlook on advanced economies, in particular the United States.

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