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Sterling’s dramatic moves around the Conservatives’ decisive U.K. election win may offer a playbook for 2020.
An election night rally, sparked by hopes for a clearer political outlook, was soon left looking over-exuberant as Prime Minister Boris Johnson hardened his Brexit rhetoric. International events added to the whiplash, as enthusiasm for phase one of a U.S.-China trade deal quickly turned to concern over a lack of detail.
December’s pattern could act as a microcosm for sterling in the year ahead, according to Andrew Milligan, head of global strategy at Aberdeen Standard Investments, with the market facing further jolts in the pound. “Brexit risk has been reduced, it has by no means disappeared. Complex negotiations lie ahead,” he said. “Valuations and positioning are helpful, the economic momentum is understandably weak but should recover into 2020.”
The initial trade deal between the U.S. and China was announced as the U.K. was voting, and helped set-up the pound’s rally by reviving risk appetite on global markets. The breakthrough removed a major global risk factor, and such conditions could provide further support for U.K. assets. Growing international confidence could helps draw fund flows, especially from Wall Street’s long-established record-breaking run.
“The greater the evidence that the world economy is improving, and companies can generate positive profit growth, then markets outside the U.S. should benefit from investors looking for cheap cyclical assets,” argues Milligan.
At home, a strong government with a working parliamentary majority large enough to last for a full five-year term could help restore sterling’s reputation for domestic political stability, if the talks with the EU proceed smoothly.
“Markets like certainty. A Conservative majority gives more clarity on some of the more existential worries,” said Chris Jeffery, head of rates and inflation at Legal & General Investment Management. “The alternative outcome of a hung Parliament would have come with a host of uncertainties about the relationship with Europe, the potential for a Scottish referendum, nationalization concerns and corporate tax rates.”
The outlook for monetary policy at the Bank of England will be key. It is likely to be refined in 2020 after its next governor, Andrew Bailey, moves back from the Financial Conduct Authority to replace Mark Carney. The Monetary Policy Committee kept rates on hold on Thursday, with two of its nine members voting for a cut.
For Aberdeen Standard’s Milligan, differentiating between the signal and the noise around U.K. assets requires the “filtering out” of short-term factors. “The objective is to take the emotion out of decision making and focus on the key drivers in terms of valuations, investor positioning, macro-economic, corporate and monetary trends.”
That could end up leading investors toward other assets classes, after the pound’s lead role in the market reaction to Brexit. “The U.K. stock and credit markets are certainly much more interesting to consider after the election result,” he says.
London’s domestically-focused equities index, the FTSE 250, hit a record high after election day, in heavy volume. The FTSE 100, home to a range of multinationals, is up by around 13% for the year. The definitive lifting of the prospect of the left-wing policies of the Labour opposition party could also encourage incoming capital flows.
For LGIM’s Jeffery, international factors also look more definitive for gilts. “Donald Trump and Xi Jinping probably have more impact on the pricing of U.K. debt than Boris Johnson and Jeremy Corbyn,” he said, referring to the Labour leader.
For the pound, investors have experience of pricing the chances of reaching a no-deal Brexit. Russell Silberston, a portfolio manager at Investec Asset Management, said the December 2020 cliff edge “could actually be good news” for the clarity it provides, at least for U.K. business.
He says sterling has been “idiosyncratic” in its trading, but that improved conditions internationally means people are willing to take on more risk. “I am sure this will help the pound.”
--With assistance from James Hirai.
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