Heading into the UK General Election on Thursday, various poll results hint at an ever-increasing likelihood of a Tory majority. From one perspective, a probable majority increases the chances of a Brexit agreement (finally!) and is quite rightly welcomed by markets. The appreciation of Sterling over the past few days, where it has broken a nearly flat six-week trading range, clearly reflects the public belief in the poll numbers. Since the EU referendum, we’ve witnessed numerous examples of poll failings, so it’s reassuring to recognise that these positive prognostications have been heavily discounted, when measured by the appreciation of the trade-weighted Pound.
The downside of this positive signal is that it increases risk-taking—why bother hedging when the expectation is for a positive outcome? Ironically, this is the same mindset we encountered prior to the EU referendum, when the low probability of a high-impact event was simply written down to zero. From that perspective, the single worst thing about good news is the propensity for decision-makers to ‘place their chips on black’ and roll the dice.
Bottom line: These preliminary reactions to positive polling indicate ‘good Brexit news’ should feed into Pound strength (potentially up to the 10-year average on the OECD’s Real Effective Exchange Rate measure or around 1.3600 against the USD), but that’s not the end of the story. UK economic fundamentals have been largely ignored, because political risk is paramount to the UK’s future direction and noise resulting from the political chaos means sentiment has negatively skewed economic readings. To some extent this is true, but there is a lot of evidence that UK fundamentals are actually quite poor, even if we can’t register the exact extent of Brexit deterioration. Given a Tory majority results in a Brexit deal, the post-deal glow might fade rather more quickly than many expect and limit Sterling in the medium-term. That’s like betting heavily on a horse which is expected to clear the hurdles and falter into the home stretch; you don’t get points for winning half a race.
The trade-weighted Sterling Index climbed roughly 1.5% last week as markets priced out political uncertainty in the run-up to this Thursday’s general election. According to polling data, the Conservatives remain on course to secure a majority as we enter election week. However, Sterling is likely to be more volatile to new reports than it has been previously. YouGov’s final MRP poll—which is regarded as one of the most accurate polls—will be released on Tuesday night. As expected, Thursday’s general election will be the focus for Sterling traders this week due to a data-light calendar.
The Euro Index erased most of last week’s gains on Friday following strong US labour market data. The index trades near the bottom of its year-to-date range ahead of the European Central Bank’s (ECB) monetary policy announcement and press conference on Thursday. Short-term resistance lies at the 50-daily moving average, which is just shy of 0.5% away from the current level.
The Dollar sold off last week, breaking through all major moving averages in the process, before rebounding on strong labour market data on Friday afternoon. Despite the sell-off, the trade-weighted index is still up almost 2.5% in 2019. The Federal Reserve is scheduled to make its final monetary policy announcement of the year on Wednesday evening, where it's expected to keep rates on hold; the usual press conference with Fed Chair Jerome Powell will follow this.