The agenda: Pound still in favour as we lead up to crucial election

The pound has made an impressive recovery in early trading after a torrid weekend and as we await Thursday’s General election result. After an initial dip when Asian markets opened, FX traders have brushed off yet another terror attack on the UK and GBP/USD is trading above 1.2850, and it is in the middle of its most recent range between 1.3015 on the upside, and 1.2769 on the downside.

The pound has made an impressive recovery in early trading after a torrid weekend and as we await Thursday’s General election result. After an initial dip when Asian markets opened, FX traders have brushed off yet another terror attack on the UK and GBP/USD is trading above 1.2850, and it is in the middle of its most recent range between 1.3015 on the upside, and 1.2769 on the downside.

Poll of polls: Tory majority still likely

Stability in the pound is significant, even though one poll for the Mail on Sunday suggests that the Conservatives only have a one-point lead over Labour, the markets are not in panic mode. Polls don’t seem to have the same impact on financial markets that they have had in the past. Partly this is due to the shifting methodology employed by some pollsters that is untested, but also because the diverse poll results make the final outcome from this election very difficult to predict. The best we can do is to take a look at the FT’s poll of polls, which puts the Conservatives in the lead with 44%, with Labour at 36%. Although the Tory lead has been eroded, if this poll of polls is correct then it would suggest that the Conservatives will win this election, but maybe not by such a comfortable majority as was expected a month ago.

Financial markets confident of a win for May, but hedging bets on utilities

Oddschecker puts the odds of the Conservatives winning a large enough majority to govern on their own on Thursday at 91%; this is only slightly down from 98% on May 8th.  The financial markets are not worried about any other outcome other than a Conservative outright majority.  This explains the pound’s relative stability: the latest positioning data for last week saw a small increase in net short positions in GBP/USD, however, short pound positions are still close to their lowest levels since before the EU referendum a year ago. Due to this, any other outcome on Thursday night could be a big disruptor for UK asset prices.

It is worth remembering that not all UK asset prices are so blasé about the election outcome. The utility sector was the weakest performer yet again at the end of last week. United Utilities Group, Severn Trent and Centrica were some of the weakest performers in the FTSE 100 in recent days. Utilities are under attack from investors because of proposals in the Labour manifesto to nationalise swathes of UK utility, energy and rail companies. We expect these companies to remain the target of the UK equity bears as we lead up to Thursday’s vote unless we see a pick-up in support for Theresa May and the Conservatives. Overall, weakness in the utilities sector is fairly localised, and hasn’t dampened broader demand for the FTSE 100, which made a fresh record high on Friday.

Don’t forget about the economy

While we expect the UK election to be the key factor driving UK markets this week, we should be cognisant of the all-important service sector PMI report for May scheduled for release later this morning. The market expects a slight moderation to 55.0 from 55.8, however, a better than expected reading could see a further recovery in GBP.

Fed numbs demand for the dollar

Central banks are also in focus. The ECB meets on Thursday, and is expected to remain on hold. It is looking unlikely that Mario Draghi will step up rhetoric that points to an early taper of its Asset Purchase Programme, which could hit the euro, but boost European equities. Also, the weak US labour market report on Friday hasn’t materially altered the chances of a Fed rate hike next week, CME Fedwatch still prices in a 95.8% chance of a hike from the Federal Reserve. However, there isn’t much expectation that the Fed will do anything else, with expectations of a rate hike in September slipping to less than 30%. This is why 10-year US Treasury yields slipped through key 200-day moving average support at 2.17%. Interestingly, USD/JPY has managed to find support ahead of the 200-day sma at 110.36. However, we expect a shallow recovery without a simultaneous recovery in Treasury yields. 

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