There's more to life than Brexit -- Oh God, we hope so ......
ref :- "Sterling's role as Brexit barometer reduced", The Financial Times, Markets and Investing
PLEASE, PLEASE tell us that it's not going to be like this every day for the next two years ..... blanket media coverage (in the UK, at least) and jittery market (over)reactions every time a negotiating official sneezes. To be perfectly honest, we were pretty nonplussed yesterday morning when sterling's weakness was being attributed in some quarters to it being the day when Article 50 was finally triggered. Yes, you could say that the Brexit process is now OFFICIALLY underway, but it's not as if this was some sort of surprise event.
We'd assume that the Scottish parliament's formal backing for a second independence referendum had more to do with the move. Or maybe it was a growing perception that Brexit-related economic weakness would be a more powerful influence on UK rates than Brexit-related currency weakness and it's inflationary consequences .... in other words, rates "lower for longer". Whatever the case however, it does seem as though the market has yet to get over its habit of flinching at every Brexit headline, Notwithstanding sterling's partial recovery from lows set in mid-March, just at the moment most of those headlines are less than optimistic -- which is why even most of the sterling bulls (still a minority market demographic) concede that the currency may well go lower in the short-term before advancing.
Actually, the FT's Currency Analysis this morning argues that the undeniable market truism since the June referendum -- that the value of the pound is a direct and close reflection of the prevailing Brexit sentiment of the moment -- is becoming less reliable. Sterling is being pushed around by many more factors than just Brexit, and evidence of this will be found in a declining correlation between Sterling -v- US Dollar (GBP / USD, or "Cable"), and Sterling -v- Euro (GBP / EUR).
Correlations are generally measured on a scale of +1.0 (meaning the two instruments in question move in absolute synchronization) , to -1.0 (meaning NO correlation whatsoever). As recently as 2015, the correlation between GBP/USD and GBP/EUR was reading below zero (less than 50% correlation), a low for over two years and a reflection of the fact that the UK's comparatively robust economy had more in common with its US counterpart than a largely stalled Eurozone economy threatened by deflation. Since last June's referendum however, the correlation has moved up to around +0.75, a historic high and proof that for the Pound, Brexit has dominated over all other factors that would normally influence currency crossrates.
It's changing though, according to the FT .... or at least it's going to. The argument goes that the shock of the Brexit vote will dissipate (well, it's a nice thought), its influence will wane and the market will get back to examining other fundamental factors that will affect the Dollar and the Euro. One interpretation of these factors is that the prospects for these two currencies are diverging.
The Dollar might suffer through the growing disappointment at Mr Trump's presidency and how much of his economic plan he will in fact be able to pull off. Repeated rebuttals of the President's travel bans do nothing to encourage an image of a man who gets things done, but it's the failure to get his healthcare bill through Congress that is really beginning to undermine confidence that his bold (and dollar-supportive) promises will be met. Without the savings that the healthcare bill would have brought, how much of Mr Trump's tax-cutting and infrastructure spending will the more fiscally righteous lawmakers within his own party let him get away with ?
And on the interest rate front, the gung-ho projections before this month's well-signposted hike by the Fed -- will there now be a total of four hikes this year ? -- have been muffled by the more cautious noises coming form Fed officials since.
Contrast that with the Eurozone, where a long-awaited recovery and rises in inflation have encouraged speculation that the ECB might soon tighten monetary conditions by reining back its massive asset-purchasing programme (QE). Politically too, things are looking rosier. Their confidence boosted by the comparative failure of the populist Geert Wilders in recent Dutch elections, the mainstream parties will now hope to see off Marine Le Pen in France without too much trouble -- at least in the second round of voting on May 7th. Even Angela Merkel and her party did surprisingly well in recent regional elections in Saarland ahead of Germany's vote in the Autumn.
Yes, there are certainly reasons why you might fancy the Euro more than the Dollar. So if you believe that Brexit will continue to undermine Sterling but that other factors will increasingly come into play, you might do better to sell GBP / EUR rather than GBP / USD. It all makes perfect sense, and as we say it's nice to think that markets might take a more measured view of the Brexit process. Regrettably however, we can imagine that the negotiations will be permanently under the microscope. It's likely that the market will read inferences into the most innocuous snippets of "news", even though the shape of things to come won't become clear for a very long time yet.