GBP left floundering in another political storm
City Index October 17, 2016 11:50 AM
<p>The pound is under pressure once again on Monday, after a weak open during the Asia session pushed GBPUSD back towards 1.2150. Part of the […]</p>
The pound is under pressure once again on Monday, after a weak open during the Asia session pushed GBPUSD back towards 1.2150. Part of the decline is down to negative political headlines: fears of a second Scottish referendum are building, and some UK newspapers reported on Sunday that the UK Chancellor could quit his post after he was excluded from government meetings because he criticised the “hard” Brexit stance of the Prime Minister.
GBP continuing to act like emerging market FX
Although the Treasury has denied that Hammond will quit his post, it doesn’t help to instil confidence in the pound. GBP is down more than 5% so far this month vs. the USD; it is also weaker against every other G10 currency. To put this month’s fall into context, the pound is weaker against the majority of emerging market currencies, including the resurgent Mexican peso, and the Malaysian ringgit. The South African rand managed to eek out a gain vs. the pound, even thought its finance minister was recently hit with charges of criminal misconduct. In fact, the pound is starting to act like an emerging market currency, with volatile price swings, and no stabiliser to limit the selling pressure. Risks of a break up of the United Kingdom and further signs of tension in Downing Street over the Prime Minister’s handling of Brexit, are the chief concerns of the currency market right now, and until these issues go away the pound is likely to remain the market’s favourite whipping boy.
A strong dollar also hurts the EUR
In fairness to the pound, the other issue is a strong dollar, which saw EURUSD breach 1.10 last week. We will be watching to see if the ECB will row back from reports that it is set to taper its QE asset purchases early when it meets this week, if it does, then we could see another slide in the EUR. If the seemingly never-ending weakness in GBP/USD leads to a breach of 1.20 in the coming days, then other asset classes could fall, including equities and the bond market (see below), as foreign investors get turned off earnings in pounds.
UK bond yields rise for the wrong reasons
Market dynamics also look troubling for the pound. The sell off in the UK bond market has seen UK bond yields rise to their highest level since June 23rd, the day of the EU Referendum. Rising bond yields are usually good news for a currency, but not when bond yields are rising for the wrong reasons. Investors are beginning to demand a higher premium for holding UK government debt because of two factors: 1, the political uncertainty and risks about the economic impact of Brexit, and 2, inflation expectations are rising on the back of a rapidly declining pound. Last week’s Marmitegate scandal between Unilever and Tesco have weighed on the bond market, as investors expect more price wars to follow suit, ultimately leading to higher prices in the shops.
Nissan could determine the short-term direction for sterling
Since rising bond yields are also negative for stocks (the FTSE 100 backed away from a record high last week, and ended Friday below the 7,000 level), in the future traders need to be aware of corporate announcements regarding price increases and investment. In the next few weeks Nissan is expected to announce whether it will make the newest version of its super popular Qashqai at its Sunderland plant. This is one of the first litmus tests of the impact of Brexit on foreign business investment here in the UK. If Nissan decides to relocate production outside of the UK then it could trigger a wave of panic in UK markets, as other large UK employers may follow suit.
Will the inflation genie come out of the bottle in the UK?
Fundamentals could come back into focus this week, with a host of key economic data releases in the UK, and important earnings announcements in the US. In the UK, CPI on Tuesday will be the key release. Prices are expected to rise 0.2% in September compared to August; however, the risk is to the upside. Core prices, excluding energy and food costs, are also expected to rise 1.4% YoY. If prices rise by more than expected, the market could see this as a sign that the inflation genie is out of the bottle in the UK. As we mention above, this could put more upward pressure on UK bond yields and weigh on the pound. Prices are rising at a difficult time for the Bank of England, and it may not be able to contain inflation if Brexit threatens to undermine the broader economy.
Employment data is also released for the UK on Wednesday, with retail sales on Thursday. Signs that consumption held up in September and employment remains strong are likely to be pounced on by the Brexiteers as a sign that leaving the EU has no economic cost. However, it is a deceptive picture to think that the UK economy is managing just fine at this uncertain time. The economic problems that the UK now faces are more insidious in nature and may not show up in the economic data for some time. Political uncertainty raises the investment hurdle in the UK, which threatens growth and employment for many years to come. So, if the pound continues to decline this week, even in the face of “good” economic data, then it is a sign that the market has a severe shortfall in confidence regarding the UK’s economic outlook.
US stocks in limbo ahead of US elections
In the US, key earnings reports to look out for include: Bank of America, Goldman Sachs, Johnson and Johnson, Citrix, eBay, Microsoft, GE, and McDonalds. So far, earnings have surprised on the upside; however, this hasn’t translated into an increase for the S&P 500, which declined 1.5% last week. With only 3 weeks left until the US Presidential election, the S&P may not rally until the election risk is out of the way.
The final US election debate gets under way on Wednesday. If Donald Trump can produce a better performance than he has managed in the previous two elections, then it could be bad news for the Mexican peso, which has been a big winner as expectations have faded that he can reach the White House.
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