FTSE pressure rises ahead of divorce bill

Good Brexit news is bad news for the FTSE.

Two stock markets

The familiar FTSE 100/sterling correlation was in full effect on Tuesday, with relatively unusual divergence between London’s ‘two stock markets’—large-caps and mid-caps. Firmer sterling weighed mechanically on the FTSE whilst lifting the more pound-sensitive FTSE 250 to a near three-week high.

Sterling shrugs off ‘backlash’

Mid-caps did fade somewhat as sterling gave back some of the 211 pip push from Tuesday’s one-week low of $1.3219. The ease was chiefly in the wake of a second look at U.S. growth data. An already robust 3% reading for the third quarter was revised to 3.3%. But the FTSE remained some 30 points lower by mid-afternoon. The market was discounting reports that Prime Minister Theresa May faces a backlash from the pro-Brexit lobby outside of the Conservative Party as Britain moves tentatively towards a “divorce bill” with the EU. A supportive reaction from Brexit-supporting cabinet colleagues to reports that Britain would pay a £45bn-£55bn financial settlement gave credence to as yet unconfirmed speculation and kept the pound underpinned. Cable was up around 70 pips at the time of writing.

Gilt yields near 18-month high

Another sign that sterling’s up leg might have some way to run was clear momentum in gilt yields; particularly for two-year bonds. They reached their highest since June 2016. Whilst their foray deeper into the 50 basis-point handle pitted the two-year gilt against resistance that stymied the rate several times pre-referendum, the bond sell-off was a sign that cross-market flows were waiting on the sidelines for a definitive divorce bill agreement. Further upside momentum is likely into the news. Even if the market then ‘sells the news’, that is unlikely to happen before the pound is propelled closer to its nearest upside challenge around $1.3455. We expect orders to be heavy around there given the aggressive sell-off that ensued when cable buyers attempted to face bears off at that price almost exactly two months ago. In the meantime, it’s far too early to call time on the FTSE’s long-term uptrend. It is depicted below in a chart of the index’s main futures contract. Note that volatility continues to pretty much flat line as shown by the sub-chart of the FTSE’s volatility index, the VFTSE. To end its rising trend, FTSE futures would need to break a corroborated rising line that has lasted since the first quarter of 2016.

Figure 1 - ICE FTSE Future continuation price chart (daily intervals)

Source: Thomson Reuters and City Index

A closer look at the futures contract (Figure 2) confirms that the market is having difficulty getting back above the 7457-7473 consolidation zone that preceded November’s six month highs above 7550. On the other hand, we also see that the FTSE’s upwards grind has mostly been squarely on the established uptrend since the middle of this month. The futures have not touched 7340 support since October, and lower support at 7234 has even more visible tags going back to April.  These are the thresholds that would need to be crossed before we get more negative on the benchmark index. That may happen if the sterling/FTSE inverse correlation begins to have effects that persist for longer than we have seen since June 2016. That looks unlikely.

Figure 2 - ICE FTSE Future continuation price chart (four-hour intervals)

Source: Thomson Reuters and City Index

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