GBP: Tips for Trading the U.K. Election

• GBP: Tips for Trading the U.K. Election
• Dollar Extends Losses as Skepticism Grows
• Euro Squeezes Above 1.13
• USD/CAD Breaks 1.20 on IVEY and Oil
• NZD Sinks on Weak Employment
• AUD Soars Despite Weaker Retail Sales, Employment Next

GBP: Tips for Trading the U.K. Election

Sterling will be in for a ride tomorrow with the U.K. holding one of its closest elections in decades.  The Conservative and Labour Party are neck to neck with neither expected to win more than a third of the votes.  We expect the U.K. to end up with a hung Parliament that could send the British pound spiraling lower.  However given that everyone from politicians to economists and investors see this scenario as the most likely, FX traders are worried that this could lead to a counterintuitive reaction in the currency.  In fact, sterling has been surprisingly resilient and even traded higher versus the dollar today.  In the week leading up to the 2010 election, GBP/USD had already lost 3 big figures or 300 pips. What is different this time around is that investors are hopeful that whoever wins will be quick to negotiate and put together a loose deal or coalition government with the SNP MPs; the Lib Dems and the Democratic Ulster Unionists.  There are many different ways that this could play out and as foreign exchange strategists we leave this prediction to the political specialists. Instead, we focus on how to trade the U.K. election.  Remember, the currency will start to move after the polls close around 10pm local time. 

How to Trade the U.K. Election

1. Sell GBP Now, Betting on a Hung Parliament and Immediate Uncertainty - The first option is to sell sterling now betting that a hung Parliament will lead to an immediate knee jerk decline in the British pound.  Given that GBP/USD dropped 400 pips on election day, uncertainty could mean big moves for the currency.   We believe this is a sound trade particularly given the recent recovery in the pound as it provides more attractive risk reward.  While GBP would probably decline against all currencies, the steepest losses could be seen versus the JPY, CAD and AUD because of the recent positive momentum in the Canadian and Australian dollars and also the risk aversion that it would create for GBP/JPY.  EUR/GBP will also rise and GBP/USD will fall but Greek uncertainty and the upcoming non-farm payrolls report could limit the moves in these currencies.

2. Place Orders to SELL GBP Below Market - Another option would be to place orders and sell sterling 100 to 200 pips below current levels on the belief that the currency will fall sharply if there is no clear winner or a coalition government is not announced.  This tactic would be preferable if you are worried about any spikes or counter moves ahead of the Election.  While we think sterling will consolidate for the next 12 hours, this is a legitimate strategy because it would not take a view on the election and instead seek to join the move only if the market is disappointed by the results.  GBP/USD dropped more than 650 pips in the 48 hours following the election so there could still be plenty of opportunity after the pair drops 100 to 200 pips. The main downside to this technique is less desirable risk reward and slippage.

3. Buy GBP/USD after a 3-4% Decline - Election uncertainty always passes and if you believe that the victor in tomorrow's election will assert himself as Prime Minister quickly and take steps to form a coalition government, then buying GBPUSD 3% to 4% lower than tomorrow's pre-election levels may be a smart technique particularly since the U.S. is poised to raise rates this year and the latest PMI services data was strong.  Even in 2010 the currency pair bounced quickly and aggressively in the days following the election and the same could happen this time around.

One final scenario is a Conservative led majority government which we believe would be the only one that would have a positive impact on sterling.  While unlikely, if enough seats are gained for the current government to remain in power, expect GBP/USD to surge above 1.55. While history does not always repeat, it is important to take a look at how GBP performed versus the major currency pairs in the days following the May 2010 Election.

Dollar Extends Losses as Skepticism Grows

Investors continued to sell U.S. dollars, driving the currency down more 1% versus the euro, Swiss Franc and New Zealand dollars.  The rapid decline in the currency reflects the market's growing skepticism about how much non-farm payrolls will rebound in April. This morning payroll provider ADP reported that only 169k workers were added to corporate payrolls last month, compared to 175k the previous month. This follows a very minor increase in the employment component of non-manufacturing ISM.  So far it seems like the only factor supporting a rebound in job growth outside of the unusually low read are jobless claims.  The forecast for payrolls is high and at bare minimum, job growth needs to exceed 200k for the dollar to avoid further near term losses. While we are hopeful, we are weary of job growth falling short of expectations.  Nonetheless U.S. rates continue to rise while stocks extended their losses - this price action signals that investors in other asset classes are still looking for the central bankto raise rates.  In fact in her speech today, Fed Chair Yellen said equity valuations are quite high (which would be consistent with a view to raise rates) and talked about how she expects long term rates to jump once liftoff occurs.  Jobless claims are scheduled for release tomorrow.

Euro Squeezes Above 1.13

The euro squeeze above 1.13 today on the back of broad based dollar weakness, stronger Eurozone data and hope for a Greek debt deal.  The Eurozone PMI services index was revised up to 54.1 from 53.7 thanks to a pickup in French activity. This along with the upward revision in manufacturing helped to boost the composite index to 53.9 from 53.5.  While these reports are encouraging they are not significant enough to explain today's strong recovery in EUR/USD.  The rise above the May 1st high of 1.1290 and 1.13 triggered a significant amount of stops that pushed EUR/USD sharply higher. This move came right around the same time as the reports that EU Junker and Greek PM Tsipras discussed over the phone steps to secure an agreement that could help pave the way for a deal on Monday.  We have been down this road before and remain extremely skeptical but at this stage, with EUR/USD closing firmly above the 100-day SMA, the next stop could be 1.1450.

USD/CAD Breaks 1.20 on IVEY and Oil

All three of the commodity currencies experienced big moves today with the Canadian and Australian dollars rising close to 1% and NZD falling more than 100 pips before reversing to end the day off its lows.  The good news continued to pour out of Canada with the IVEY PMI index surging to 58.2 from 49.2. This was not only the first month in 4 that manufacturing activity accelerated but it was also the strongest pace of growth since September 2014.  Crude prices also surged above $60 a barrel to reach its highest level in nearly 5 months. The combination of positive data and rising commodity prices provides the fundamental backdrop for a move down to 1.18 and possibly even 1.16 for USD/CAD.  Meanwhile AUD/USD traders were unfazed by softer retail sales growth as an uptick in new home sales and stronger Chinese service sector activity gave them enough reason to stay long AUD.  Yet the rally could lose steam if tonight's employment numbers come out as expected - economists are looking for job growth to slow signficantly and for the unemployment rate to rise.  Finally, NZD fell sharply overnight on the back of very weak employment numbers. The unemployment rate was supposed to fall to 5.5% in the first quarter but it was revised up to 5.8%. The employment change dropped to 0.7% from 1.2% and average hourly earnings sank to 0.2% from 0.4%.  Last month, the RBNZ talked about lowering rates if demand and inflation weakens and based on today's report, that could become necessary.