- Despite high expectations, Conservative Party conference showed that party is far from unified
- Brexit uncertainty, weak growth outlook and stretched sentiment weighing against the pound
- Rate hike expectations one of the few bullish drivers today
While hopes were high for a show of unity from the Conservative Party conference, its aftermath suggests that this optimism was misplaced. Following Boris Johnson’s ‘red lines’ article in The Sun, questions regarding Theresa May’s leadership have begun to appear. This morning, Sky News reported that May is not considering resigning, despite her keynote speech that was interrupted by coughing fits and a prankster. Given rising support for the Labour Party, May has tried to placate the public by promising investments in social housing, a freeze in tuition fee levels, energy price caps and a promise to increase NHS funding. While the promised investments are helpful, there are few reasons to be bullish on the pound today.
Politics, Brexit, economic growth and sentiment working against the pound
Not much to show after four rounds of negotiations
With lingering questions regarding May’s ability to stay in power, markets are lowering their expectations for a Brexit deal. Instead, ‘hard Brexit’ is looking more likely, with the pound selling off accordingly. While Brexit secretary Davis and his counterpart Barnier were optimistic about getting to a deal a few weeks ago, tangible progress has been limited in recent times. This morning, Germany’s BDI industry association raised its concerns regarding the lack of progress in a statement, suggesting that German companies must prepare for hard Brexit.
Growth revised down, with most survey data soft
After initially reporting year-on-year real GDP growth of 1.7%, Q2 growth was recently revised down to 1.5%. While May's promise to increase government spending will support short-term growth, businesses have been hesitant to invest until Brexit-related uncertainties are resolved. Unsurprisingly, growth rates have fallen since the referendum. Despite the ongoing upturn in the broader Eurozone and strong US figures, economic growth in the UK has been falling in rate-of-change terms since peaking in Q4 2014. While recent services PMI data was healthy, other sectors such as construction and manufacturing have been weak. A historical perspective of UK real GDP growth rates are shown below:
When will the cycle turn?
Sentiment at extremes, despite small long pound positions
Looking at data from futures markets, speculators are now long the pound. Previously, CFTC data showed that speculators have been short the pound since November 2015. They have recently flipped following the Bank of England’s minutes which suggested an interest rate hike is likely in the near future. While net long positions in the pound are very small (with only 2,218 contracts net long), this nonetheless represents a bullish extreme based on trailing 1-year data. Specifically, today's net long position in the pound is more than two standard deviations above the 1-year average.
In late March 2017, speculators were at the other extreme, and were more than two standard deviations more short than the 1-year average at the time. In our broader take on futures data, we questioned why traders were selling GBP/USD at 1.25 and buying at 1.35.
Bank of England: buy the rumor, sell the news?
With domestic politics, Brexit, growth and sentiment all working against the pound, the main reason to be optimistic towards the currency today is based on the expectation of a future interest rate hike. Given the strong run up in the pound since early September, this is mostly priced in and thus remaining a pound bull is a tough sell for us. Our medium-term outlook on the currency remains bearish as a result. While the pound may be due for a small rebound in the short-term, the forecast remains cloudy in the longer term.