Sterling will continue to bear the brunt of the Brexit news agenda, with the currency’s movements set to stay volatile for the foreseeable future, according to the BlackRock Investment Institute.
Despite developments this week, there is a greater chance of a hard Brexit, according to Marilyn Watson, head of BlackRock’s global fundamental bond product strategy team.
And that is most likely to play out in the currency market, with moves on Monday showing that sterling is at the whim of Brexit-related news events. After David Davis’s resignation as Brexit Secretary the pound strengthened as the market hoped for a softer Brexit. However, that move was reversed after Foreign Secretary Boris Johnson quit. It closed Tuesday 0.1% lower than where it ended last week.
“Volatility in the pound has increased significantly over the past two years,” explains Watson. “We think it will continue to be the instrument where we see really the market’s expression of the Brexit outcome.”
As a result, Watson says her team has been very actively trading sterling in order to take advantage of its volatility. They currently have both call and put options on the currency, which means they can profit whether it appreciates or depreciates. “We do think the range of outcomes and the tail risks on both sides are now more extreme now,” she adds.
This strategy has worked well in the year to date. Sterling’s long downtrend since the Brexit vote came to an end in early 2017 and the pound finally recovered to the level it had traded at before 23 June 2016 in mid-April this year.
FTSE 100 to Benefit From Weak Sterling
However, since then it has sunk by 7.5%. Of course, sterling weakness is good news for the FTSE 100 and in that time the UK’s blue-chip index, which is packed full of companies that earn their revenues in US dollars, has surged by around the same amount.
In fact, the UK is one of the few markets that are seeing analysts upgrade their earnings estimates for 2018, notes James Bristow, managing director and portfolio manager in BlackRock’s global equities team. Though he cautions “obviously that’s predominantly driven by FX translation and energy, given the composition of the market”.
Still, as a result, European ETF investors piled into UK equity large cap funds in the second quarter of 2018, to the tune of €1.2 billion according to Morningstar Direct data. That makes it the fourth most-popular global category in Q2, and is the highest quarterly inflows total since the first three months of 2016.
The Morningstar Bronze Rated SPDR FTSE UK All Share ETF (FTAL), UBS ETF MSCI United Kingdom (UC64) and iShares Core FTSE 100 ETF (ISF) have all been beneficiaries.
And Bristow says there are definite opportunities on a stock-by-stock, rather than sector-by-sector, basis. “I think there are opportunities in the big global companies that have benefitted from a weak sterling, whose drivers of growth are clearly outside the UK,” he explains.
“But also, selectively, there is clearly some very significant value emerging in domestic UK franchises, where we can find a sense that expectations are very low, where we have the financial margin of safety with a very strong balance sheet and where we back management’s turnaround.”
Will Bank of England Raise Rates in August?
On a wider view, Watson says the UK economy remains on a robust footing, with weak data seen at the beginning of the year reversing as the weather continues to improve.
She expects the Bank of England to raise rates at next month’s Monetary Policy Committee meeting, with economic indicators now beginning to tick up and unemployment continuing to stay low.
Markets tend to agree with that assessment, with a 78% probability of an August hike now priced in, though many other commentators caution that it is by no means a foregone conclusion. Ben Brettell, senior economist at Hargreaves Lansdown, is one who thinks Mark Carney and team will stick.
“The second quarter is likely to see a small uptick in GDP, but when added to the below par first quarter, this means growth in the first half of the year will be decidedly sub-trend,” he says. “I can’t see how this makes a particularly strong case for higher rates at present, particularly as Brexit uncertainty casts an increasingly threatening shadow.”
