'Sterling has largely priced in a messy UK Election outcome' - Simon Smith, FxPro

 

   Simon
   Smith

PROFILE:
• Current Job: Chief Economist for FxPro
• Career: Holds an MSc. in Economics from the University of London and a BSc. from Brunel University. He has held economic and strategy positions with Standard & Poor’s.

View profile at FXStreet

Simon Smith has over seventeen years experience of macro forecasting and investment strategy research. Prior to joining FxPro in May 2010, Simon was a consultant with Thomson Reuters, having spent four years as Chief Economist at Weavering Capital. 

Simon has held economic and strategy positions with Standard & Poor’s, together with consultancy firms 4Cast and MMS International. He holds an MSc. in Economics from the University of London and a BSc. from Brunel University.

Jitters ahead of the UK election have kept the pound vulnerable over the last weeks. Do you believe a hung Parliament is already priced in? Or how this outcome could affect the GBP?

In comparison to the last election in 2010, sterling has traded a lot more defensively in the run up, so a hung parliament is certainly in the price at this point in time. How the pound trades going forward naturally depends on the make-up of the parties once the results are in. The worse outcome is one of no overall majority and no coalition being formed, so either main party having to govern on a vote by vote basis. The latest data (up to March) showed record inflows to Gilts, despite the prospect of the election, so for now investors do not seem perturbed. Even on the worse outcome above, it’s unlikely that we will see markets fall out of bed, but it’s the more bearish one for the currency. Overall, sterling has largely priced in a messy outcome, having fallen through most of March.

Will the outcome of the UK election impact on the BoE rate hike agenda?

The impact of the election on the rate outlook is primarily through the change in fiscal policy that emerges and secondarily through the degree of stalemate in the political process. On fiscal policy, the thinking is that a labour minority government, seeking a vote by vote agreement with the the SNP would be the worse case scenario, with markets fearing a tighter fiscal stance, but the wider economy (investment, discretionary spending etc.) being held back by the ensuing uncertainty. I guess the most bullish outcome for the rate outlook is a continuation of the current coalition or conservative majority, because markets are more comfortable with what they know and fiscal plans would be broadly unchanged from current ones. On balance, I still see the Bank of England keeping rates steady through to next year.

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It seems expectations of the Fed lift-off have shifted to September amid weak US economic data over the winter months, putting the dollar under pressure after reaching multi-year highs across the board. Do you see the dollar resuming the bullish trend in the short-term?

I see the dollar retaining the more cautious and consolidation stance. Nothing lasts forever in FX and that had to be true of the unprecedented dollar rally August last year to February this. But the yield story has also been a factor, the push lower in the Eurozone and the subsequent correction higher we’ve seen, especially in Germany has been a major factor in the recent price action. At best, I see the Fed tightening rates at the tail end of the year, the BoE in 2016. The past few weeks have reminded us that there are no one-way bets in FX.

On Friday we have another key US employment report. What do you think it needs to be its outcome for the USD to regain strength?

I think the risks are skewed on the payrolls and the dollar reaction. If we see stronger data, I think it will largely be seen as validation that the March weakness was transitory, but the Fed has a decent jobs market as a given. It had already moved away from a mid-year tightening before these numbers. They were merely the final nail in the coffin of a June rate hike. I think weaker numbers would see a larger number of those structurally long the dollar throw in the towel, hence the feeling that the potential reaction is skewed to the downside.

Stock markets continue hanging around record high levels. Do you expect any downward correction on the main indexes?

With regards to stocks, we're seeing opposing forces. Low yields are acting as a decent support, but higher yields have proven to be a head-wind recently. I was never a buyer of QE in the Eurozone being a strong support for stocks, because the dynamics are very different in comparison to the UK and US. So the going will be tougher in my view, for the US especially and to a lesser extent, to the Eurozone.