Mini panic over May unlikely to have lasting impact on the pound

The pound has dropped 1% so far today, and is back below the $1.31 level after a report in the Sunday Times argued that 40 MPs are now willing to vote against Theresa May stoking fears of a leadership challenge before year end.

The pound has dropped 1% so far today, and is back below the $1.31 level after a report in the Sunday Times argued that 40 MPs are now willing to vote against Theresa May stoking fears of a leadership challenge before year end. We have known that Theresa May’s position as Prime Minister is tenuous after her failed gamble in this year’s election. However, she still won the most seats compared to any other leader, and it remains unclear who would be a successful challenger in the Conservative Party considering the cabinet, from the outside, looks like a den of iniquity.

The perils of unsubstantiated stories…

However, even though a leadership challenge doesn’t appear a realistic option right now, the souring of the political outlook in recent days -  Theresa May has lost two members of her cabinet in as many weeks - has jolted investors out of their Autumnal slumber. 1-month GBP/USD volatility had sunk to its lowest level since May last week, but it has since risen sharply, as we can see in chart 1. This tells us something about market psychology: when markets get too complacent, unsubstantiated stories can trigger a bout of volatility and a rush to the exits.

It is worth putting this move into context: GBP/USD is still trading within November ranges. If this story has legs and we see a potential ousting of May by her own party, then we would expect the pound to fall further. However, if this story quietly goes away and Tory MP’s keep a lid on their bubbling frustrations with the PM, then we could see 1.3040 – the low from 3rd November, act as key support. Even 1-month volatility for GBP/USD is only back at early November highs around the 8.00 level, this is below the mid-October high when volatility peaked at 9.0.  

Beware complacency regarding the pound

So, what does this mean for the pound? Firstly, today’s move tells us that the markets are on alert for political risks emanating out of the UK, and if there is a party coup to replace Theresa May then political turbulence is likely to weigh on the pound further. Secondly, even though the pound has had a jolty start to the week, volatility and technical signals do not suggest to us that the pound is about to fall off a cliff just yet, we may need this story to develop further to get another big move lower in sterling. Thirdly, don’t get too complacent about the pound, the political and Brexit situations remain fluid and can throw up surprises. In future, when volatility is low in the pound investors should be on their guard that a pullback is likely.

On the bright side, a weak pound has been good for the FTSE 100 so far, which is leading the European stock indices higher at the start of this week, although it has not been so good for the FTSE 250, which is down 0.6% so far, as the smaller UK index is more UK focused and thus sensitive to political risks.

Chart 1:

Source: City Index and Bloomberg  

Build your confidence risk free
Join our live webinars for the latest analysis and trading ideas. Register now

StoneX Financial Ltd (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.