Brexit pressures weigh on the pound as the FTSE soars

Sterling dominated market action on Monday as the market digested the news that UK PM Theresa May will trigger Article 50 no later than March next year. The Tory party conference is turning into a sell for the pound, as FX traders get spooked by May’s apparent sanguine attitude to leaving the single market, preferring to focus on immigration and UK sovereignty rather than the economic fallout of Brexit.

Phillip Hammond, the UK’s new Chancellor, didn’t help the pound either when he suggested that George Osborne’s fiscal rules will be abandoned and government spending increased. This is designed to cushion some of the blow from the UK’s departure from the European Union. However, it is likely to weigh on the UK’s already large budget deficit, which is another blow to the pound at the start of the new quarter.

FTSE investors look on the bright side

Interestingly, the same can’t be said for UK stock indices. The FTSE 100 briefly touched 7,000 at one point on Monday as the market took comfort from the weaker pound, which should be good news for UK exporters. As you can see in the chart at the end of this article, GBP/USD and the FTSE 100 have an inverse correlation: as the pound has plummeted to multi-decade lows, the FTSE 100 has risen to multi-year highs. While the pound remains weak, we would expect this relationship to continue.

One thing that could knock the FTSE 100 temporarily on Tuesday were some reports late last night, suggesting that the UK government won’t prioritize protection of the UK’s financial services sector once the UK has left the EU. This could weigh on the UK’s large banking sector, and could trigger some profit taking on FTSE positions this morning. As expected, the FTSE 100 is expected to open a touch lower on Tuesday.

Fed-watch could overtake Brexit

The other theme for this week is the US rate rise. There is the plethora of US economic data that is scheduled for release in the second half of this week, including the ADP employment report, non-manufacturing ISM and the September NFP report, which is released on Friday. Global economic data is fairly thin on the ground on Tuesday, with European PPI and UK construction PMI the only highlights. Thus, we could see fairly range-bound action in the markets until we get more clues as to the potential timing of a Fed rate rise.

GBP/USD managed to hold above the July low on Monday and 1.28 is likely to be a sticky level for cable for the next few days. Whether or not we make a decisive break below this key level, or if this pair stages a mini-recovery, is likely to be reliant on the outcome of Friday’s labour market report. Such is the importance of the September US jobs data that the bigger risk is now to the downside. The market is expecting a rebound after August’s disappointing numbers. However, if that does not materialise then we could see a sharp fall for the dollar, and a rebound in Treasuries, which fell (yields rose), in reaction to a better than expected non-manufacturing ISM on Monday.

Watch out for hawks at the Fed

Also worth noting on Tuesday is a speech by Richmond Fed President Lacker at 1300 BST/ 0800 ET. Although he is not a voting member of the Federal Reserve this year and he doesn’t have a say on policy, he is considered the most hawkish member of the Fed, and last year was a keen dissenter. He argued back on September 2nd that rates should be significantly higher and the Fed is risking economic stability by keeping rates so low. He is likely to reiterate the same message when he speaks at the West Virginia Economic Outlook Conference. Watch out for even more urgency from Lacker, or any sign that other Fed members share his view on the need to raise rates. If this materialises then it could boost the dollar and weigh on US stock indices on a day when there is little else to distract the markets.

Overall, Tuesday could be the calm before the storm and market volatility could be muted. We expect ranges to persist as we approach some major levels in the pound and the FTSE 100, in particular. We expect Brexit to remain in focus until Theresa May’s second speech on Wednesday, after that we expect the market’s focus to shift back to Fed-watching and the US payrolls report on Friday.

This material is published by Minerva Analysis LTD for information purposes only and should not be regarded as providing any specific advice. Recipients should make their own independent evaluation of this information and no action should be taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It is not intended for distribution in any jurisdiction in which this would be prohibited. Whilst this information is believed to be reliable, it has not been independently verified and Minerva Analysis LTD makes no representation or warranty (express or implied) of any kind, as regards the accuracy or completeness of this information, nor does it accept any responsibility or liability for any loss or damage arising in any way from any use made of or reliance placed on, this information. Unless otherwise stated, any views, forecasts, or estimates are solely those of Minerva Analysis’ employees, as of this date and are subject to change without notice. We use a combination of fundamental and technical analysis in forming our view as to the valuation and prospects of an investment. Past performance is not a reliable indicator of future results.

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