Forget Brexit talk, its Trump that really matters for the pound this week
City Index February 27, 2017 5:21 PM
<p>On an otherwise quiet Monday, the pound is the worst performer in the G10 FX space so far today. The trigger was two news reports […]</p>
On an otherwise quiet Monday, the pound is the worst performer in the G10 FX space so far today. The trigger was two news reports that surfaced on Monday, the first which suggests Theresa May could trigger Article 50 as early as mid-March and bring an end to freedom of movement for EU citizens at the same time, and the second was the near-certainty of a second Scottish Referendum.
FTSE 250 more at risk from rash immigration decisions
These reports are not really new news, but they have focused the mind on the impact of Brexit, and how close we are to initiating the process to leave the European Union. Theresa May could score political brownie points by immediately limiting freedom of movement of EU citizens in the UK, however, that could have a major impact on UK businesses. This hasn’t impacted the FTSE 100 today, but it is impacting the FTSE 250, which is down more than 0.5% so far on Monday. Medium-sized UK businesses are likely to be hit hardest by any measure to limit freedom of movement of EU citizens, which is why this index could be more at risk from a Brexit sell-off once Article 50 is triggered than the FTSE 100.
Bond market nonchalance at Brexit prospects
Interestingly, the bond market does not seem as concerned by these reports as the FX market. UK Bond yields have jumped higher today, the 10-year yield is up some 10 basis points. We don’t think that this is reflecting a higher political premium for UK government debt, after all 10-year yields are still at their lowest level since October. Instead the sharp rise in UK yields is part of a global recovery in sovereign bond yields after steep falls last week.
Brexit reports likely to have fleeting impact on the pound
While the pound is still vulnerable to political shocks, as price action on Monday confirms, Brexit is not the only story out there for the pound. Trump’s address to Congress on Tuesday night, European election risks and UK economic data could all change the tone for the pound, so it could be a week of two halves for sterling.
If GBPUSD can stick above 1.2390-1.2410 – a cluster of moving average support, then this would suggest a limit to how far the pound could fall, at least in the short term. While Brexit headlines are dominating on an otherwise quiet Monday, we have no idea if Theresa May will actually block freedom of movement, or if she can do this from legal standpoint at this early stage of our Brexit negotiation. We are still years away from officially leaving the EU and a Scottish referendum on independence is unlikely to happen for the next two years. Thus, today’s reports may not materialise for some time, which is why we think that there impact will be fleeting.
Trump bigger driver of GBP in the near-term
In contrast, the immediate risk to the pound could come from President Trump’s address to Congress on Tuesday. The dollar and the US bond market seem to have lost faith in Trumpenomics, 10-year US Treasury yields fell to their lowest level since November on Friday and the dollar index is 2% away from its December high. If Trump can put flesh on the bones of his pro-growth economic plans, then US bond yields could rise and drag the dollar with them, if he fails to do this then we could see further dollar weakness.
Yields also don’t support today’s decline in the pound. The chart below shows GBPUSD and the UK-US 10-year yield spread, this usually moves in a similar direction, but in recent days the pound has fallen while the UK-US yield spread has actually risen. If this corrects itself then the pound could recover.
So, don’t put too much stock on Brexit headlines and Monday’s price action. Trump’s speech is a far more important risk even this week, and could determine whether we see further weakness back to 1.20 or if we get a recovery rally back towards 1.27 in GBP/USD. The real price movement is likely to happen late Tuesday/ early Wednesday, Trump will talk at 0200 GMT. Set your alarm clocks on Tuesday night and get ready for this week’s most important event for sterling.
Source: City Index and Bloomberg
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