UK economy plays into Theresa May’s hands

The UK service sector has caught up with the manufacturing sector, and today’s PMI data for April suggests that the UK economy will rebound once more in Q2, after a disappointing start to the year.

The UK service sector has caught up with the manufacturing sector, and today’s PMI data for April suggests that the UK economy will rebound once more in Q2, after a disappointing start to the year. This has been greeted by a bounce higher in the pound, although GBP/USD hasn’t been able to sustain gains above 1.2900 so far.  

As we move into election season, the UK economy is playing into Theresa May’s hands, which could help to reduce political uncertainty as we lead up to the General Election next month. This is significant for UK assets, particularly the pound, which has been very sensitive to UK political risk post-Brexit. Thus, an easy win for Theresa May next month combined with a pick-up in UK economic data could help GBP/USD break through the 1.30 barrier in the coming weeks. As we lead up to the election on June 8th June, UK economic data will be just as important as the polls for traders to keep an eye on.  

A vote for the status quo = good for FX, but for how long?

In fairness, a win for May is already boosting the pound, GBP/USD has rallied more than 400 pips in the last month, as the market expects the public to vote for the “status quo” and hand Theresa May an easy victory in June. A vote for the status quo in France in the first round of the Presidential election, has also helped boost EUR/USD by some 300 pips in the last two weeks. If Macron can seal the deal and win the keys to the Elysee Palace on Sunday, it will be interesting to see if the euro can continue to rally or fades out. If the euro falters post after a Macron win, then we could see the same thing happen to the pound if Theresa May wins in June.

Eurozone economy still on fire

Aside from politics, economic fundamentals are gaining in importance as drivers of asset prices. The Eurozone economy remains the global bright spot, with its service sector PMI rising to its highest ever level. We have pointed out that European data has surpassed expectations even as the US and UK have seen some data disappoint, however, figure 1 below shows how the hard data is now clearly indicating Eurozone outperformance compared with the US and the UK.

Is further European stock market outperformance on the cards?

This is interesting for Eurozone stocks, especially since the European indices are less over-valued on a price/ earnings ratio compared to some UK and US indices. For example, the Dax, Cac and Ibex have P/E ratios of 19.13, 20.00 and 19.71, respectively. This compares with 35.57 for the FTSE 100, 21.31 for the S&P 500 and 32.91 for the Nasdaq. A favourable valuation compared with a reduction in political risk and a good run of economic data could trigger further outperformance of the Dax relative to the Dow Jones. Figure 2 shows the Dax and the Dow, the chart has been normalised to show how they move together. The Dax started to outperform the Dow in March, and may continue to do so based on the above analysis.

Conclusion:

Overall, politics is playing into the euro and pound’s hands, leaving the dollar a little awry in the major markets. Whether or not the euro can sustain gains if Macron wins is worth watching, as it could give us a steer on what to expect for the pound in the aftermath of an expected victory for Theresa May next month. When it comes to stocks, we expect to see continued European (Dax) outperformance compared to the US, as political risk ebbs and economic data continues to shine.

Figure 1: 

Source: City Index and Bloomberg

Figure 2: 

Source: City Index and Bloomberg 



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