FTSE, sterling respite unlikely to last

<p>The government has in effect signalled that it can do to little to shield investors from the bouts of considerable volatility that policymakers themselves see as likely.</p>

The announcement by Chancellor of the Exchequer George Osborne that both an ‘emergency Budget’ and his all but inevitable departure would be delayed, brought short-term reassurance for UK markets on Monday, limiting their declines.


But the government also in effect signalled that it can do little to shield investors from the bouts of considerable volatility that policymakers themselves see as likely to occur.


Aside from what was essentially a reiteration of reassurances given by the Bank of England governor Mark Carney on Friday, Osborne was not able to provide any further certainty on key procedural questions (particularly when Article 50 will be triggered).

It is uncertainty surrounding such questions that are contributing to sterling’s softness. The Prime Minister has stated that he intends to leave the task of triggering Article 50 to his successor, and we don’t expect him to go back on that at the European Council summit this week. That leaves sterling with no more visible means of support than it had on Friday.

On top of that, the Chancellor conceded that “the volatility we have seen, and are likely to continue to see in financial markets”, is a significant challenge. Whilst there’s now no doubt that the government and the Bank of England are, as Osborne stated, “prepared for the unexpected”, it would make sense for authorities to wait for much more extreme conditions than those seen on Monday before deploying their well-telegraphed firepower.

More widely, political and economic uncertainty continues to have sufficient momentum to enhance jitters.

  • Perhaps the earliest pinch point will be the question of the Labour leadership. After more than a third of Jeremy Corbyn’s shadow cabinet resigned within the space of 24 hours, the eventual conclusion of Labour’s latest internal eruption could bring a more market-friendly leader than the one currently in post, though much depends on signals this week from Corbyn himself. Either way, the (officially undeclared) Conservative leadership race will be the main event. Markets will watch for the risk that a more rightward leaning candidate than Boris Johnson may begin to gain ground.
  • In Scotland, whilst Scottish National Party leader Nicola Sturgeon has stated that she would use all means at her disposal to prevent or delay a Brexit, the best assessment of constitutional opinion does not suggest a favourable chance of that happening. As for the matter of a second Scottish referendum on UK membership, whilst attractive for the SNP, we assume a reversal of signs of a recent more unionist trend among voters, and stability of oil prices above $50 would be required. That’s even before long and tortuous negotiations between Westminster, Holyrood and Brussels can begin.
  • On the trade front, the outlook for negotiations between the UK and the EU threatens to bring less favourable arrangements than apply now. But before they begin, a new leader of the ruling Conservative Party must be appointed, probably in October. Realistically, the formal notice to the European Union under Article 50 required to trigger a 2-year break up, is unlikely to be posted till January 2017, muting immediate trade-related threats, but allowing them to overhang markets till 2019.


In the meantime, given that sterling and FTSE options positioning has been booked in unprecedented volume into the autumn and winter, sharper outbreaks of volatility are all but inevitable.


For the FTSE, we note that the option deal with the biggest open interest of any based on the benchmark index targets a fall to 5000 by December. Whilst the beneficial impact of a weaker pound for exporters, including those listed in the FTSE is more than theoretical, the impact of Brexit on sentiment will continue to be erratic and indiscriminate.

Note that short trades in our ‘Pro-Brexit’ model portfolio on banks, retailers, insurers and housebuilders—equity sectors sensitive to a UK/EU split—have rocketed. Most notably, a basket of housebuilders’ shares nosedived by another 36 percentage points between Thursday and Monday’s close.

That suggests even the strongest names in the sector were sold off sharply.


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From a technical basis, the FTSE 100’s destruction of long-term trends during its whipsaw last week increased the chance that 2016 lows which the index has remarkably evaded so far, will come back into play.

The weekly chart of Intercontinental Exchange’s FTSE Future index (below) shows it has entirely invalidated a potential bull flag that capped the end of a rising channel in place since at least July 2009.

The bearish ‘outside week’ was sufficiently unusual to prevent all but the most temporary rebounds taking place. That would suggest the index’s approach to the upper bound of either the long-term trend (white) or the shorter-term pattern flag (thin light blue) would bring a bearish outcome. Similarly, we would not expect values above last week’s close at 6103 to be sustainable.




Please click image to enlarge




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