Sterling's Onward March Continues
Sterling's onward march continues with the currency touching a fresh 6-month high against most majors.
This was due to the currency markets ignoring the week’s macro-conomic UK data releases. UK GDP, employment and earnings data, CPI inflation and retail sales, all came out on the weaker side. However, as has been broadly the case for the past three years, politics dominated with the 12 December election remaining the centre of attention. Polls suggest that support for both Conservatives and Labour – has risen, while that for ‘remain’ parties (including the Liberal Democrats) and the Brexit Party has fallen. Given a potentially higher incidence of tactical voting, pollsters have shied away from making firm predictions.
From a markets perspective, the most significant political move of the past week was the Brexit Party’s decision not to field candidates in the 317 seats won by the Conservatives in 2017. Not all experts were convinced about the significance of such a move for the election outcome, especially as the Brexit Party said it would still contest Labour seats targeted by the Conservatives (although today’s reports suggest it has stood down in some of these seats). Nevertheless, bookmaker odds now attach about a 60-65% probability to a Conservative majority, whereas such an outcome was previously seen as more or less evenly balanced versus a hung parliament. Still with nearly four weeks between now and the election date a lot could happen.
The pound has rallied towards $1.29 and €1.17 during the week, but uncertainty about the election outcome remains high. For example, one-month GBPUSD implied volatility in the options market, which now includes the post-election period, jumped up to a four-week high, with the spread over the one-week implied volatility spiking higher.
That suggests currency volatility could increase further as the election approaches. While GDP data confirmed the UK economy rebounded in Q3, hence avoiding a technical recession, survey evidence continues to paint a less upbeat picture.
US interest rates are set to remain on hold at least through the rest of the year, having been reduced in each of the previous three meetings. Market attention will remain on prospects of a near-term ‘phase one’ trade deal with China and impeachment proceedings on President Trump. It remains unclear whether the latter will significantly affect Trump’s re-election chances, while markets continue to gyrate on trade headlines. At the time of writing, White House economic adviser Kudlow described a deal as ‘close’ but ‘not done yet’. A trade accord would be expected to result in a repricing of market rates closer to the Fed ‘median’ view, but the precise outcome of negotiations remains far from certain.
The minutes of President Draghi’s final ECB policy meeting in October (due next week Thursday) are likely to reaffirm the need for monetary policy to remain accommodative, while reiterating a plea for fiscal policy to play a bigger role in supporting growth. Draghi’s argument was that more fiscal stimulus would shorten the time that interest rates remain in negative territory, something which is disliked in Germany and other northern European countries. Whether new ECB President Lagarde finds more success in persuading governments with fiscal headroom to loosen their purse strings remains to be seen. For now, the German government is showing no signs of readiness to embark on fiscal largesse (probably reinforced by the upside surprise to Q3 GDP growth), while a central fiscal capacity in the Eurozone seems some years away. Next week’s Eurozone flash PMIs (Fri) are expected to reaffirm a picture of sluggish economic growth. Lagarde also has to heal the divisions within the Governing Council after the acrimonious decision in September (Draghi’s penultimate meeting) to reduce rates to -0.5%, restart QE and commit to maintaining such measures until the inflation goal is met. In that context, a number of ECB speakers will garner particular attention next week, including the President herself (Fri), as well as Bundesbank President Weidmann (Fri) who opposed the resumption of QE.
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See you next week!