British pound heads for a rocky ride after UK election chaos
Five big investment themes likely to dominate thinking of investors and traders in the coming week
1. Fed hike seen certain, but then what?
The US Federal Reserve looks almost certain to raise interest rates for the second time this year, by 25 basis points to 1 to 1.25%. What concerns investors, though, is what happens next. When Donald Trump won last November’s presidential election, US stocks and Treasury yields soared and the dollar strengthened on expectations that extraordinary fiscal stimulus would supercharge an economy already on the mend, pushing up inflation and giving the central bank the space to raise rates. However, low expectations for growth and inflation and battered faith in Trump’s ability to enact the promised measures has taken a toll on that trade. The dollar is back where it was before the Nov. 9 election, 10-year Treasury yields are pinned well below 2.3%. What does that mean for interest rates – will the Fed react by slowing the pace of rate increases? Investors will be hunting for clues to whether this may herald a slower pace of rate hikes.
2. Not so strong, and not so stable
“Strong and stable” was the mantra UK Prime Minister Theresa May hoped would win over the country and sweep her to a landslide election victory. But it failed for her, and it doesn’t look like it can be applied to sterling either. Sterling volatility has usually been lower than euro volatility. But the political chaos in Britain – some say May is unlikely to survive for long, and another snap election later this year may be on the cards – comes just as the Brexit negotiations formally get under way. Which comes just as the economy is slowing. According to the OECD, UK growth next year will be the lowest of all 32 countries in its latest global outlook report bar one. What’s more, Britain will be the only one of those 32 countries to post slowing growth four years in a row from 2014 to 2018. So sterling looks set for a rockier ride than otherwise might have been expected, although the expected volatility probably won’t be as bad as that seen after last year’s Brexit vote. Some analysts say the pound could fall back to $1.20 before recovering. “Not so strong, and not so stable”.
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3. Bang to REITS
Real estate investment trusts (REITs), with their holdings of London office space, were the worst-performing stocks on the FTSE all-share the day after a stunning election upset – an indication traders were dumping stocks considered most vulnerable to Brexit. But what happens if Brexit turns out “softer” than appeared likely before the election, as many in markets now suggest? The pressure on REITs, which hasn’t really eased since last June’s Brexit referendum, could begin to lift. That makes some hefty assumptions about May’s negotiating stance, though, and some more bearish observers reckon more uncertainty could be in store.
4. Greek boomerang
Greece, the euro zone’s finance ministers and the IMF meet in Luxembourg on June 15 knowing that another Greek default may be on the cards in July if it doesn’t get another shot of aid money. There are still differences of view on what needs to be done to make the country’s debt – 180% of gross domestic product – seem sustainable. The Greeks want debt relief now, Germany and others want to wait until next year to ensure Athens stays in line. Then there is the big question for bond markets. Would the now-traditional fudge deal that kicks the can down the road be enough to get the European Central Bank buying Greek debt? If so, Greek could be lining up its first debt sale since a brief return to markets in 2014.
5. Gulf ripples
A spat between Qatar and a bloc of Arab states led by Saudi Arabia has caused ructions on local financial markets that might deepen in the coming week and ripple outwards should tensions escalate. Qatari stocks are down 7% and its riyal has fallen in one-year forward markets to the lowest since end-2015 QAR1YV=. Some big Qatari companies have come under cyber attack, the latest being satellite TV channel Al Jazeera. Risk insurance costs across the region have surged and the weaker Gulf states, Bahrain and Oman, may suffer peg pressure, too. But Turkish President Tayyip Erdogan has upped the stakes by giving the green light to Turkish troop deployment in Qatar. Turkish warplanes and ships may also be sent, the newspaper Hurriyet said. A supportive global backdrop has so far protected Turkish markets, but that may change if the conflict turns violent.