Sterling and the UK election
As the UK’s general election reaches its final stages, investors will be looking ahead at what to expect from the new government.
All eyes will be on sterling, which has in the past year become the main conduit for investors’ changing sentiment about the country’s uncertain future.
The new prime minister will have a demanding domestic agenda. but for markets the most important signal from the election result will be what it means for Britain’s relationship with the EU.
If, as the polls predict, the Conservatives win a sizeable majority, it could give Theresa May more elbow room to carve out a Brexit deal while disempowering hardline Eurosceptics in her party — a prospect that boosted demand for the pound when the election was first called.
A narrow Tory win or a shock Labour victory could see the currency sinking back to test last year’s post-referendum lows again.
Sterling took a dip last week after a poll showed the Tory lead narrowing. However, analysts at JPMorgan argue that the prospect of a centre-left coalition could be positive for the pound.
ECB as the eurozone recovers
When European Central Bank officials meet to discuss monetary policy in Tallinn on June 8, the most likely change is expected to be a tweak to the institution’s language. Interest rates will remain below zero for an extended period, but the central bank may remove the possibility of them moving lower from the statement of guidance it gives to the public, a reflection of economic improvement.
What bond market investors will be watching is any discussion of the asset purchase programme, which buys €60bn of securities each month. Mario Draghi, ECB president, this week damped expectations of any swift announcement of a reduction in buying.
Speaking to the European Parliament, he said risks had receded and Europe’s economic upswing was increasingly solid. However, he said he was “firmly convinced” of the need for monetary stimulus and reiterated his institution’s commitment to providing it. The comments led Citi economists to lower already modest expectations for action: “Even the guidance change we currently expect [dropping the reference to lower interest rates] is not a foregone conclusion.”
What next for the Fed
As far as investors are concerned over when the Federal Reserve will next tighten policy, many see June as a near certainty. The market implied probability that the Fed will raise its target policy rate by 25 basis points to a corridor between 1 per cent and 1.25 per cent stands at 86 per cent. The real question on investors’ minds is what happens next? The June policy meeting could provide some clues.
Minutes of the most recent Fed meeting gave some additional detail on the potential for the US central bank to begin winding down its balance sheet by the end of the year. Policymakers have contemplated ending the reinvestment in its more than $4tn mortgage-backed security and Treasury portfolio. That, in turn, should put upward pressure on interest rates, serving in tandem with higher policy rates in tightening financial conditions.
“All the signalling and posturing from the Fed is for a June [rate rise],” says Todd Lowenstein, director of research at HighMark Capital Management. “The Fed seems to be more outlook-dependent than data-dependent, and absent a destabilising shock they are set on their agenda . . . to normalise policy.”
Weaker data of late, a falling dollar and low longer-dated Treasury yields have cast doubt as to how fast the Fed can continue on its tightening trajectory. Traders put the odds that the Fed will have lifted its target rate by 75bp by year’s end at 44 per cent. That is down from as much as 59 per cent in mid-May.
MSCI and Chinese shares
June 20 sees the return of MSCI’s yearly “will they, won’t they?” ritual, when it decides whether to include mainland-listed Chinese shares in its popular emerging markets index.
The addition of mainland stocks into an index tracked by $1.5tn of assets would be a watershed moment for Chinese markets. Mainland regulators have been courting foreign investment for years, but suffered a big setback following the dramatic stock market bubble and bust of 2015. MSCI’s endorsement would surely be welcomed by Beijing.
This will be the fourth time the question has been asked, but recently the mood music has changed. BlackRock is now backing the move, which would effectively force global fund managers benchmarked against MSCI’s EM index to add Shanghai and Shenzhen equities to their portfolios.
Regulatory changes over the past year, such as the opening of the Shenzhen stock connect, will also have bolstered the case for inclusion.
Reporting by Kate Allen, Josh Noble, Dan McCrum, Joe Rennison and Eric Platt