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Currency Market Analysis

Dec 12, 2019 | Currency Market Analysis

Global Themes

  • Election day is underway
  • Polls open 7:00am until 10:00pm
  • Exit polls published at 10:00pm (first indication of result)
  • Expect choppy price action from this point
  • Official result in early hours of Friday 13th
  • Conservative majority expected & GBP to strengthen
  • Hung parliament big downside risk to GBP
  • Investors race to protect against pound falling

GBP

Election scenario snapshot (Election Scenario Matrix here)

The UK election is gearing up to be an extremely volatile event over the next 24 hours. The exit polls will be released at 10:00pm and the pound is expected to be ultra-sensitive to the results. Moves of 1-3% higher or 1-5% lower cannot be ruled out. Where will GBP-currency pairs be trading this time tomorrow?

 A Conservative Party majority is the expected outcome based on opinion polls and sterling is widely expected to benefit as a result. GBP/USD might tackle new year highs above $1.34, perhaps on towards $1.35, whilst GBP/EUR could breach €1.20. Gains may be limited though depending on the size of the majority and given the uncertainty of future UK-EU trade talks during the 2020 transition period.

 A hung parliament is an increasing possibility given recent opinion polls. This week, the release of YouGov’s important and historically accurate MRP poll showed the Tory’s lead has shrunk and a hung parliament is within margin of error. This is seen as sterling negative as parliament will remain gridlocked and Brexit and economic uncertainty will be prolonged. A knee-jerk 4% deprecation of sterling could unfold. GBP/USD could fall towards $1.25 and GBP/EUR towards €1.13.

 A Labour Party government is an unlikely scenario that could rattle the pound and send it towards the lows of this year. However, the possibility of Labour leader Jeremy Corbyn becoming Prime Minister through a coalition government could see sterling shoot higher. The pound may rally on hopes of Brexit being reversed combined with a watered down version of Labour’s high spending plans.

  •  If no majority is won, PM Boris Johnson remains in office until it is decided who will attempt to form a new government. There may be talks between parties about forming a coalition government or a confidence and supply arrangement. Another election in January may even be called.

 Warning signals in GBP options

GBP-related options are sending warning signals as the election result looms. Expectations of extreme volatility in sterling are growing and demand to hedge GBP downside risk is at its highest since the EU referendum. Currently, GBP/USD floats near 9-month highs and GBP/EUR near 2-½-year highs.

Although the pound has remained elevated on hopes of a Conservative majority, in the background, the options market is sending warning signals that risks lie ahead. It shouldn’t come as a big surprise that volatility is expected to ramp up from the time the exit polls are published tonight. Businesses targeting a particular exchange rate might benefit from placing an order to capture a desired rate should the market spike higher or lower. Implied volatility, which reflects how much exchange rates are expected to change over different time periods, reveals that overnight GBP volatility risk at its highest since the 2016 referendum night.

  •  Meanwhile, investors are ramping up demand to protect against the pound falling. The premium to purchase GBP-puts (hedging against sterling falling) has increased to highs not witnessed since the referendum in 2016. It is a clear indication of the perceived threat of sterling depreciating on any other outcome than a Tory majority.

USD

Fed rocks dollar, tariff talks eyed

As expected, the US Federal Reserve (Fed) left its benchmark interest rates unchanged between a range of 1.50% and 1.75%. The US Dollar weakened last night and has extended losses this morning with GBP/USD clinching new 9-month highs and EUR/USD breaking above the $1.11 handle.

The Fed hinted at keeping rates on hold throughout next year having cut three times in 2019, which prompted investors to sell the dollar. Fed Chairman Jerome Powell also commented on tepid inflation and although leaving growth and inflation forecasts unchanged, its unemployment outlook was revised lower, suggesting the Fed wants inflation to pick up naturally via a tightening of the labour market.

  •  In a busy day ahead, US President Donald Trump will meet with top advisers about the tariff deadline currently slated in this Sunday, Dec. 15. US-China trade talks have stalled recently though many investors predict tariffs won’t be enforced. A surprise twist in this story could certainly rattle financial markets. 

Lagarde’s first ECB meeting

The European Central Bank (ECB) holds its monetary policy meeting today and an announcement will be made at 12:45pm. No changes to policy are expected but it is Christine Lagarde's first meeting as ECB president so any signals of future changes will be closely monitored.

The market assumption is that Ms Lagarde will have a dovish bias – with the main objective to influence fiscal policy in the near term as opposed to altering monetary policy. This could see the Euro surrender some of its gains achieved overnight following the dovish Fed surprise. Conversely, in the unlikely event of a hawkish twist by Ms Lagarde today, expect the Euro to build on its gains.

  •  EUR/USD is flirting with a key upside resistance area around the mid-$1.11 zone. The currency pair has the 200-day moving average to contend with at $1.1153, but a break higher could accelerate upside traction and may be a strong indication for a long-term trend reversal.


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