Friday, June 9, 2017

FX: "Sterling Shocked, Dollar Broadly Firmer"

From Marc to Market:
What looked like a savvy move in late April has turned into a nightmare. Collectively, voters have denied the governing Conservative party a parliamentary majority. The uncertainty today does not lie yesterday with the known unknown, but with the shape of the next government and what it means for Brexit.

The thinking now is that the Tories could form a coalition with the Irish Unionists, who also favor Brexit. Contrary to expectations, Prime Minister May has not offered her resignation and insisted that she will stay. Our concern pre-election was even in victory May would be a weaker leader. Some are concerned that another election may have to be held later this year.

Sterling had appreciated for four consecutive sessions before yesterday minor decline. It had risen eight of nine sessions. The sharp sell-off, the bulk of which took place in the immediate reaction to the exit polls that pointed to a hung parliament as soon as voting ended, took sterling to about $1.2635 from around $1.2955. In effect, sterling retraced, almost to the tick, the 38.2% of the rally from the year's low just below $1.20 in mid-January. The next target is the $1.24-$1.25 area, and that seems to be a reasonable objective in the coming weeks.

It is understood that UK rates will be lower for longer. There is a slight bullish steepening move in the debt market (debt instruments have rallied across the curve with the short-end rallying more). UK equities are mixed. The FTSE 100, with its currency sensitivity, has rallied a little more than 0.6%, but the real performance is mixed, as the FTSE250 is down 0.8%.

We had noted that some investors had seen the FTSE 100 as a way to position for the election. If the Tories had expanded their mandate, UK stocks would have rallied. If the Tories did not do so well, the rally in FTSE 100 would blunt some of the impacts from a weaker sterling. Some would have hedged the currency.

The conceit is that a hard or soft Brexit will be determined by the next government. Once Article 50 was triggered, the initiative shifted from the UK to the EU. As long as the UK insists on asserting its sovereignty over its borders it cannot expect to share in the single market, where sovereignty has been abridged, on equal footing.

Besides the loss of the Tory majority and the unexpectedly robust showing for Labour, two other observations stand out in these early hours. First, the Scottish Nationalist Party did poorly, and this will undermine efforts for a second referendum. Second, young people had a very strong turnout--above 70%. It is not clear the extent that this was a due to Corbyn's draw or the retaliation for the referendum where young people typically had voted to remain....MORE