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Editor's Note: Hamish Risk | September 8, 2020
There’s a sense of dread in the Brexit playground as two old disgruntled classmates meet again, the prolonged COVID-induced summer vacation over and the reality of long fractious lessons on game theory setting in, as the days shorten and the odds of a trade deal lengthen. Hard to believe that the sterling has been the second strongest major currency against the US dollar this summer, but perhaps not for much longer, says 4X Global Research, where they describe the ”quadruple whammy” that is set to hit the UK. Most market participants, says Heteronomics, are well aware of the Brexit problem and the lack of progress, but the occurrence of brinkmanship rather than the realisation of a welcome early resolution still raises the risk premium on UK assets. However, where there is life, there is hope and Goldman Sachs explains why the lure of an exit deal may be difficult for UK government to resist before the end of a difficult year. Elsewhere, Blonde Money, one of our resident Brexit specialists, gives the topic a wide berth, instead, focussing on the more productive exercise of how investors can create effective analysis from high frequency mobility data, now omnipresent in these COVID times, but still in its relative infancy as a leading indicator. Finally, macro quant firm, Quant Insight argues while government stimulus is the 800 pound gorilla in driving asset prices in the current regime, FX markets remain the best asset class to express a macro view and to extract alpha.
1. Brexit – brinkmanship beckonsThe UK’s future relationship with the EU has been going nowhere fast for most of the past four years, says Philip Rush at Heteronomics, but the year-end expiry of transitional arrangements can potentially provide some pressure to break the deadlock. However, he says building that pressure takes brinkmanship, which the UK government is welcoming with its credible threat to end talks next month. Most market participants, says Rush, are well aware of the problem and the lack of progress, but the occurrence of brinkmanship rather than the realisation of a welcome early resolution still raises the risk premium on UK assets. That risk premium is likely to weigh on sterling over the next month, in his view, and the longer negotiations drag on for, the more that dynamic is likely to build.
Brexit investor positioning Sterling 4X Global Research
2. Sterling facing potential quadruple whammySterling has enjoyed a strong, if bumpy ride, since late-June, says Olivier Desbarres at 4X Global Research, who points out the pound has been the second strongest major currency against the US dollar, thanks in part to a build-up of speculative long-sterling positions. He says markets have seemingly taken heart from government measures to support the economy, the Bank of England’s so-far unflinching commitment to quantitative easing and the sharp rebound in economic activity in June-August. At the same time, says Desbarres, markets have ignored the British economy’s material underperformance relative to other major economies in the second quarter and the government’s arguably incompetent and incoherent handing of the Covid-19 pandemic. However, he says the economy faces a potential quadruple whammy in coming months of fiscal stimulus measures being unwound, a no-deal Brexit, higher taxes and a re-tightening of national lockdown measures in the event of the number covid-19 cases rising sharply during the winter months. This leaves the pound vulnerable, says Desbarres, particularly in the context of relatively elevated long sterling speculative positions.
Brexit European Union Goldman Sachs
3. Brexit – stuck on state aidAs the eighth round of post-Brexit trade negotiations begins, Adrian Paul at Goldman Sachs says the thorniest issue at the heart of the impasse between the UK and the EU is Britain’s ability to subsidise key industries at its own discretion. He acknowledges the risk that the UK government might ultimately decide that minimal market access is a price worth paying for maximal regulatory autonomy, however he believes the allure of a Brexit deal before the end of a difficult year will be hard to resist. In the absence of a free trade agreement, Paul says Prime Minister Johnson would face the triple threat of a resurgent Scottish National Party, an increasingly popular leader of the Labour Party, and a crucial test of competence in the recovery from Covid-19. It is almost inevitable, he says, that the perceived probability of “no deal” will escalate over the coming weeks, but he maintains the terminal outcome of Brexit negotiations is most likely to be a “thin” free trade agreement ratified by December, with zero-tariff/zero-quota trade in goods but significant non-tariff barriers predominantly affecting trade in services.
COVID-19 Economic indicators People movement Blonde Money
4. Mobility data – what does it tell us?Helen Thomas at Blonde Money has released the first in a series of research on the velocity of people and how it will be impaired for years to come due to the coronavirus pandemic, reducing potential economic growth and rendering conventional fiscal and monetary stimulus impotent. She says the usual signposts of economic activity have become unreliable, with government schemes skewing measures of employment, while shutdowns have left calculations of inflation incomplete. To fill the gap, says Thomas, attention has turned to high frequency data releases from alternative sources such as Google and Apple, who have harnessed their many mobile phone users to measure people’s movement and routing requests respectively. She has decided to evaluate that data differently to other analysts, however, considering the speed of recovery instead of looking at the levels of movement. Movement, according to Thomas, has been curtailed throughout the world, but more in Europe than Asia, with cultural differences have affecting movement at least as much as government restrictions. Online shopping, she adds, cannot fully offset the hit to consumption. Thomas highlights the example of Singapore, which she argues has perfected the art of the lockdown.
alpha generation macro signals Quant Insight
5. The stories moving the marketQuant Insight’s framework looks to understand asset price movements and valuations by distilling signals from its quant models that cover thousands of securities in real time. They then use algorithms to untangle and isolate which macro variables (typically correlated) are driving asset prices. Furthermore, their models can identify which assets will be most sensitive to changes in particular macro factors. According to Mahmood Noorani, Quant Insight’s founder, government stimulus is by far and away the single-largest factor currently driving asset prices currently. Noorani says fiscal and monetary stimulus has outweighed the horrible fundamentals of GDP growth, with a policy focus on driving down credit spreads creating a one dimensional trading environment that is dependent on expectations over how aggressive official stimulus packages are likely to be in the future. This idea that there is one policy bet means diversification is harder to achieve says Noorani, while also making markets more fragile. Indeed, he argues it may be the case that companies, such as those in the tech sector, that can tell a convincing idiosyncratic story around innovation have become more expensive because they are viewed as diversifiers – whether they can deliver on the promise or not. As for the repression which is shackling fixed income markets, the best expression of a macro view, Noorani says Quant Insight’s models say that equities and FX markets are the best ways to express a view, particularly FX, which has become much more sensitive to inflation expectations than rates. The recent rally in the euro versus the dollar is a prime example of this. We’ll expand on this subject in tomorrow’s briefing.