1 - Swirling Sterling

Consensus view: Markets are pricing in another choppy year of negotiations between the United Kingdom and the European Union. This is clear from the post-election surge in Sterling having dissipated rather quickly; it hit $1.35 in the immediate aftermath of the results but fell right back to $1.30 the following week. The realisation rapidly dawned that the election merely signalled the beginning of negotiations surrounding the future relationship with the EU, not the end. Prime Minister Boris Johnson is sticking steadfastly to his position of the UK leaving the transition period at the end of December 2020 with a permanent trading relationship in place with the EU. Most find this untenable, with such negotiations usually taking years to conclude.

What the consensus view is not pricing in: The consensus may not be pricing in sheer exhaustion! Most minds are anchored by the recency bias of the last three years, where much “noise” has been generated by missed deadlines and crossed “red lines”. However, following the original referendum, and now a general election, it is clear most British people want to leave. Most Europeans want this over with too, with little appetite for “punishing” the UK at the cost of prolonging the morass. And while trade deals usually take longer, a negotiated settlement may be easier in this instance given near-identical starting positions on many rules and regulations. It also gives the UK the ability to cut taxes and regulatory red tape, actually breathing life into idea of the “Singapore on the Thames”.

Potential market reaction:

• Macro: Sterling hits $1.75 and €1.55 as a major headwind for the UK disappears.Pent-up corporate capital expenditures jump along with consumer spending. Bad inflation (“cost-push”) is replaced with the good kind (“demand-pull”).

• Equities: All else equal, one can expect large-cap UK equities to fall given the inverse correlation between Sterling strength and repatriated profits at the multi-national behemoths that populate most of the FTSE 100. However, much of this will be blunted by a genuine, comprehensive trade deal with the UK’s largest trading partner, helping investors “look-through” any short-term currency headwinds. Moreover, domestically oriented companies, as many of the mid-caps on the FTSE 250 are, will rally. All companies will benefit from the more favourable tax and regulatory backdrop.

• Bonds: Government bonds will sell off aggressively as investors dump safe-haven, low-yielding assets and invest in riskier ones. The yield on the UK ten-year gilt may double, even treble, from the current level of 0.80%.

Our positioning: In most strategies, a net bias to risky assets and an overweight to UK equities leaves us well positioned for the upside. However, this outcome would negatively impact the non-Sterling parts of our global-oriented portfolios, which is precisely why we have trimmed the non-Sterling exposures by insulating (“hedging”) part of our US equity positions and all gold holdings against a rise in the value of Sterling.