Bracing for the election

Today's news headlines:

  • ‘China suffers biggest state firm Dollar bond default in 20 years’. Tewoo Group—a major Chinese state-owned commodities trader—has defaulted on Dollar bonds, causing investors to absorb heavy losses. The event marks the biggest state-owned Dollar bond default in two decades and underlines Beijing’s struggle to contain credit risk in a deteriorating economy. (Bloomberg)
  • ‘Year-end funding strains accelerate as attention now on Fed’. Short-term funding markets across the globe are starting to feel the strain of year-end demand as markets look to the Federal Reserve for a solution. Markets fear that short-term interest rates will spike as demand ‘bottle-necks’ the cost of short-term borrowing, like it did in September. The Fed is expected to intervene to provide liquidity as we enter year-end. (Bloomberg)

‘Twas the night before the election result…

Sitting in our London office, it’s clear that the entire UK is bracing for today’s election, and the subsequent results, because there is a feeling that this one is particularly meaningful. The sense is so strong that we’re extending our opening hours, because it’s clear this event will be a direct determinant of Brexit itself. The political uncertainty surrounding Brexit has had a similar effect on the run-up today as well, leaving many unsure about the correct approach to trading this event. From our vantage point, it’s best viewed in a historical context—acknowledging that there’s always another risk event around the corner—and so focus on fundamentals rather than trying to call the outcome. For most businesses, this means trading consistently with their commercial requirement and largely resisting the temptation to bet too large one way or the other.

Bottom line: Based on the degree of Sterling appreciation over the past week, numerous news headlines have reasoned that a potential move around the election is more likely to be downward than upward, so-called asymmetrical risk. We think that statement is hard to judge and instead prefer to view the current range in the context of the trade-weighted Pound. The top of the post-Brexit trade range is about 3.0% above our current position. If we can make a reasonably basic assumption that the top of this range is likely to pose an impediment to Pound appreciation, a likely top for Sterling could be around 1.36 against the US Dollar. This, of course, implies that Sterling continues to appreciate which is, in our view, less reasonable. 

graph.png11111.png

Trade-weighted Pound – Source: Bloomberg

GBP/USD

Overnight, the pair broke through the 1.32 level following the Fed’s announcement to keep rates on hold. The outcome of the UK general election will begin to emerge from 10pm, meaning London trading hours may be quiet in anticipation for this evening. Greater Sterling volatility should be excepted late tonight and early morning.

GBP/EUR

The pair continues to trade relatively flat in the high 1.18’s as both components of the currency cross gains on broader Dollar weakness. The focus will be on the ECB policy announcement this afternoon as Lagarde takes the stage for the first time. Euro volatility is likely to drive the pair throughout the day before Sterling takes over later this evening as general election results begin to appear.

EUR/USD

Overnight, the pair gained as the US Dollar sold off following the Fed’s announcement to keep rates on hold. The pair broke through the 1.11 handle after testing the level yesterday. Further gains are likely to be capped at the 200-daily moving average which currently sits at 1.1155. Markets will be watching Lagarde this afternoon as she makes her first policy announcement followed by the usual press conference.