Traders play politics with the pound, as May steps in
City Index January 9, 2017 5:21 PM
<p>The pound has dipped to its lowest level since October on Monday after Prime Minister May said on Sunday that we couldn’t keep bits of […]</p>
The pound has dipped to its lowest level since October on Monday after Prime Minister May said on Sunday that we couldn’t keep bits of the EU, fuelling fears of Hard Brexit. On Monday she said that she doesn’t accept the terms ‘hard’ and ‘soft’ Brexit, and declined that her comments yesterday were a change of stance. This ‘backpedalling’ has done nothing to reverse the decline in the pound, which dropped to a low of 1.2125 before lunchtime, and instead makes it likely that further interviews with the Prime Minister will become even harder to score, due to her far from clear message about what Brexit will entail.
Traders flirtation with GBP was short lived…
Unsurprisingly, the pound is the worst performer in the G10 today, however, we would note that downside momentum was building up for the pound last week, as traders once again re-established short positions in GBP vs. USD, according to the latest CFTC data on speculative positioning. After some respite at the end of last year, the market increased short bets on sterling even before Theresa May gave her interview on Sunday, suggesting that until a clear plan is presented by the government, the market’s fear that Brexit will be a disaster for the UK.
This is important, if politics are everything for the pound, then we would expect to see further declines in the coming weeks, until we get some concrete detail about what the UK’s exit from the EU will actually look like. Thus, we could see back to the 7th Oct low at 1.1841, sooner than some had thought. Conversely, we may not see a GBP bounce until well after Article 50 is triggered and the market feels comfortable about what the future for the UK looks like.
Pound bucks better economic data and higher yields …
Interestingly, the pound is bucking a recent run of better than expected economic data, including better than expected service and manufacturing PMI reports for December, which suggest that the UK economy has done remarkably well in the aftermath of the Brexit vote. It is also bucking the recovery in the UK-US yield spread, which had been as wide as -1.23% in late December, but recovered to -1.04% last week. Although economics and yields are a key driver of a currency, sometimes politics matters more, and that appears to be the case this time. Pound bulls better hope that May does in fact want a soft Brexit, otherwise the pound is likely to continue to get a hammering.
It could be worse for GBP…
The only currencies doing worse than the pound today are the South Korean won and the Turkish Lira. Turkey’s currency has been under particular pressure, and fell to a fresh record low on Monday after Moody’s, the credit-rating agency, warned about the adverse impact of higher security on the economy would pose a threat to the country’s banking sector. The fresh high in USDTRY is now 3.73, but it continues to jump higher this morning. While President Erdogan has said that there will be no one-off interest rate increases to try and reverse some of the losses in the lira, we think that this may still happen, particularly if we see further heavy losses of 1-2% per day in the coming days. A large interest rate rise of 10% plus could trigger a sharp reversal for the Lira, and a turnaround for USDTRY.
Futures trade suggests that the Dow may have to wait to hit 20K
While the FTSE 100 is the best performer in Europe today, mostly due to its inverse correlation with the pound, the futures market suggest that the US equity markets may open down later. We expect the Dow to reach 20,000 in the coming days, but it is a big level that will require a deep breath from the markets, especially since the Trump-fuelled rally is all based on expectations for future policy and not reality. As we mentioned on Sunday, there are some signs that the US equity market could be losing its nerve: the decline in the Russell 2000 and the Dow Jones Transportation Index, both lead indicators, are worth watching in the coming days as they suggest that a pullback is likely if, or when, we hit the bull’s-eye for the Dow Jones.
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