GBP takes a breather but still looks good as we head into election season

GBPUSD is backing away from the 1.2860 high from earlier in the session today, but after a 300-point jump in GBP/USD since yesterday the market is poised to take a breather. Also there could be some nervousness as we wait for Parliament to debate the motion to hold the General Election on June 8^th. The debate takes place at 1230 BST, with the vote expected some time later. A win for May could see another pop higher for the pound.

Non-political reasons to like the pound right now

Aside from the political boost the pound received on Tuesday, there are other reasons to think that sterling has further to go on the upside. Positioning data is heavily skewed to the downside, in fact short speculative positions in GBP/USD are close to their lowest ever level. This doesn’t marry with the improvement to the UK economic outlook and to the UK current account deficit, which shrunk to 2.4% of GDP in the last quarter of 2016 from 5.3% in Q3 2016. Add to this a dramatic scaling back of prospects of a US rate hike in June, and an improvement in the pound’s fortunes was on the cards even before Theresa May’s announcement on Tuesday.

Why this election doesn’t increase uncertainty for the pound

In and of itself the UK election shouldn’t be a key driver of UK asset prices, particularly if Theresa May wins a landslide, as she is expected to do. This election shouldn’t change domestic policy too much, and Brexit was going to happen with or without the vote on June 8th. However, f the polls are to be believed about the Tory lead over Labour then this election could add certainty to the UK’s Brexit positioning stance and to domestic policy for the next 5 years, and that is good for markets. For GBP/USD 1.30 is now in view, and as we lead up to the election then we could see more unwinding of the GBP/USD short positions which could take us to 1.35 around the time of the election result.

The pound vs. the FTSE 100, what is going on?

What’s good news for the pound is bad news for the FTSE 100, which turned negative for the year earlier. The inverse correlation between the FTSE 100 and GBP is alive and well, however, we think there international factors are more important to the FTSE 100 right now, which is why it is ignoring the “positive” political noise from Westminster.  The FTSE 100 is sensitive to the drop in iron ore prices, which have hurt commodity companies, who make up a significant portion of the FTSE 100. Also, global stock indices have had a poor run of late; so overall market forces could also be weighing on the UK index.

In the short-term, global indices seem to be tracking the price of iron ore (and thus China’s demand for steel), pretty closely. The mini-recovery in the iron ore price this morning could trigger some profit-taking in short stock index positions, and may also see the FTSE 100 pick up off of its recent lows at 7,120 ish. The FTSE 100 could also be volatile as we lead up to Q1 earnings season in the coming weeks. If the US is anything to go by, then it could be a mixed bag, which may not be enough to protect UK stock indices from further downside.

Why the FTSE 250 could follow sterling higher

Interestingly, the FTSE 250 is outperforming the FTSE 100, even though it did come under pressure on Tuesday as the pound surged. We think that this index could be better protected from the downside forces weighing on the larger indices, as it is more correlated to the performance of the UK economy. The FTSE 250 is only 150 pips away from its record high, and new historical levels could be on the cards for this index, even if the FTSE 100 falters.

Further signs French election risks could be receding

Keeping an eye on the French election, with less than 5 days to go before the vote Marine Le Pen’s odds of winning the overall election (both rounds) have fallen further to 23.64%, Far Left firebrand Melenchon has also seen his odds fall back to 11.36% from a high of 14% late last week. Francois Fillon is in second place behind Emmanuel Macron. After a very weak campaign, Fillon is making a comeback, and a Fillon/ Macron second round cannot be ruled out. If this happens then we think the euro, Cac 40, Dax and Eurostoxx index could be big winners at the start of next week, as all of these asset pries are negatively correlated with the French bond yields, and tend to rise when French bond yields fall, which we would expect if Melenchon and Le Pen are eradicated in the first round of voting.  For EUR/USD 1.0843 is key resistance on the cards.

UK in focus once again

Ahead today, all eyes will be on the UK Parliament where the Commons will debate the motion to hold the General Election on June 8^th. If this is passed then we could see another pop higher in GBP later this afternoon. The Fed’s Beige Book and the final reading of Eurozone CPI are also worth watching. Overall, UK politics is stealing the limelight once more and GBP has come out of the Brexit shadows to rise again.