May's Bold Move and Fed Expectations

UK Prime Minister May surprised the global investors and world policymakers by calling snap elections, precisely what the 2011 electoral law sought to prevent by fixing the date of elections.  As recently as before the Easter break, May's office denied the persistent speculation that she would (or should) maneuver for early elections.  It is not an ethical or moral issue.  It is pure pragmatic realism.  The benefits of an election outweighed the costs and risks by a margin that could not be refused. Bold decisions are often those that achieve many objectives and this is not exception.  The window opportunity may not have been open for very long. 

There is the long-run strategic objective of ensuring that the conclusion of the Brexit negotiations are not held hostage by electoral politics and the previously scheduled election in 2020. There is the opportunity offered by her popularity which is helping to give the Tory Party more than a 20-point lead in the polls. Labour's Corbyn is a vulnerable leader.   Labour is expected to be trounced in the May 4 elections.  There is some risk that the defeat force Corbyn out.  Waiting too long, could risk facing a stronger Labour Party. UKIP appears to be faltering, losing to Labour in a special election in  district that voted in favor of Brexit.  It sole member of parliament, Carswell recently resigned and become an independent. The Liberal Democrats are positioned to pick up a few seats from its current nine (especially in Southwest England), but the Tories can pick up many more seats from Labour (especially in Northern England and Midlands). May will achieve her own mandate, which in turn strengthens her hand against both domestic rivals (within her party) and in negotiations with Europe. 

There are risks associated with May's move. To pull the end run around the 2011 electoral law, May needs the approval of Labour to secure the 2/3 votes needs. Corbyn quickly handed May his noose, while the Lib-Dem's leader Farron also accept the gauntlet, and may be trying to position himself as the anti-Brexit leader.  If her motion were to fail, it would force the less desirable alternative of a vote of confidence that May must lose to win the election.

The dollar's slide yesterday was surely partly a function of sterling surge, which seemed to be more a function of short covering that a belief that a UK election and the likely larger Tory majority will change the economic dynamics in the six-month to two-year time frame. On the margins, if sterling can hold above its 200-day moving average, it may on the margins soften some of the inflation pressure created last year's devaluation.  However, the past inflationary impulses do not appear to have peaked. Chancellor of the Exchequer Hammond will offer a new budget, which is needed in any event after his proposal regarding the tax for national insurance for self-employed was summarily rejected.

The other major development is the decline in US rates, which is going well beyond what most imagined.  First, consider expectations for Fed policy.  No one really put much stock in a hike in May, but the odds of a June hike have fallen sharply.  As recently as April 7, Bloomberg estimated that the June Fed funds contract was discounting a little more than a 55% chance of a hike.  Now it is below 40%.  The CME's model has the odds near 42%, but was higher than Bloomberg.   The two-year note is the most sensitive part of the coupon curve to Fed expectations.  It yield fell from 1.30% in late March to 1.16% yesterday.  We suspect the pendulum has swung too far away from a June hike.   Today's Beige Book, however, likely has little bearing.

Second, consider the 10-year yield. The yield peaked the day before the Fed hiked in the middle of last month near 2.63%. Yesterday if fell to nearly 2.16%. There seems to be two main drivers. The first in response to the less than hawkish hike and was similar to the profit-taking seen after the December 2016 hike. The other part seems to be a combination of safe haven and the downgrading the odds of the Trump Administration's economic program.  Many observers see the double top in yields above 2.60% and the violation of the neckline around 2.30%. However, the value of the technical pattern is the future projection, which in this case would be near 2.0%. While referring to the pattern, many draw away from the conclusion.  Is 2.0% 10-year US yield a realistic possibility?

The US dollar is firmer against the major currencies today as it consolidates against sterling and the euro. The yen, which had been the star performer did not make new highs yesterday as did sterling and the euro. The dollar is trying to carve out a shelf ahead of JPY108, but it needs to resurface above JPY110 strengthen the base. The euro is a quarter cent range.  A break of $1.0680 is needed to signal anything of importance, otherwise short-term operators will look for $1.0780-$1.08. Sterling is finding bids ahead of $1.28, and technical potential extends toward $1.30. The dollar-bloc currencies continue to underperform.