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Mind the gap in Sterling

FTSE new records like a broken record

Reports of new records on the FTSE 100 sound like a broken record. “An Nth new record for the FTSE as the pound falls” can still be uttered a few more times if Theresa May hints at a “hard Brexit” in her speech on Tuesday. Britain’s leading stock index hit a fresh intraday high on Monday before pulling back as the pound recouped some of its losses.

 

Royal Bank of Scotland led a decline in banking stocks after a broker downgrade. Banks stand to benefit from better lending margins and more fixed income trading associated with higher interest rates but a “hard Brexit” is bad news for lenders in the UK. The banking sector has been a big contributor to the run of record highs in the FTSE 100 so bank share price declines on Monday weighed on the index.

 

Mind the gap in Sterling

The British pound fell to a fresh three-month low against the dollar (three-decade low if you exclude the flash crash in October) and two-month low versus the euro on Monday morning before rebounding in afternoon trading.

 

The reports in the Sunday papers of Theresa May indicating a “Hard Brexit” are either a) pure speculation based on her TV interview last week or b) the government knows Sterling will tank if a hard Brexit is announced so have leaked it beforehand to distance the move in the market from the PM's speech.

 

We believe Theresa May will be coyer than is currently being priced in currency markets so the damage to the pound could be limited. The UK will probably end up leaving the single market but Theresa May is unlikely to say as much before Article 50 is triggered. The government will not want to rule out staying in the single market in order to control immigration without first understanding the flexibility of EU trade negotiators behind closed doors.

 

The issue of a “hard” or “soft” Brexit is misnomer because there are countless possible arrangements outside of the single market. Bilateral trade deals and even EU budgetary contributions are soft options that the government can still explore. Theresa May could try to outline some alternatives to being in the single market in her speech but it would need to be very well-worded to avoid sparking fresh panic in markets. Still, any relief in Sterling could be an opportunity. We remain bearish GBP/USD because of the uncertainty presented by leaving the EU and the policy divergence with the Federal Reserve.

 

Gold on stealthy 3-week winning streak

Gold has risen for the last three weeks and by the end of last week had closed 12 of the last 14 days higher. A 0.7% rise in the price of gold has come at the same time as a more severe 2.4% fall in the US dollar index. It would appear that for now, investors are shunning the dollar rather than loving the yellow metal.

 

As the ultimate safe-haven, destabilising politics is playing a role in setting the price of gold. Gold topped in 2016 two weeks after the Brexit vote and saw some of its most severe losses in the days after Donald Trump’s election as US president. Gold saw one of its biggest daily gains this year after Donald Trump’s press conference veered away from fiscal stimulus and tax cuts towards attacking the US healthcare industry.

 

We expect a pro-growth agenda under Donald Trump and a limited global impact from the UK’s Brexit plans to put gold back under pressure soon. However, if the UK opts for a hard Brexit and Donald Trump spends his first days in the Oval office adding trade tariffs rather than unleashing ‘animals spirits’, gold stands to gain further.

  

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