A week is a long time in politics and this promises to be a week unlike any other.
The government has announced a long prorogation of parliament, widely seen as a move designed to limit debate. Opposing MPs have responded by drafting legislation to extend the Article 50 deadline so a No Deal Brexit can be averted. However, Prime Minister Boris Johnson has said he will not ask to extend the Article 50 period under any circumstances, which makes a snap General Election ahead of the EU summit on 17 October the most likely outcome should this legislation pass.
With opinion polls divided between four or five political parties and the situation highly fluid, political predictions will be extremely difficult. With this degree of uncertainty it’s no surprise that the pound’s volatility on the foreign exchange markets has surged to a level only once exceeded since the 2016 referendum (chart 1). To put this in context, the pound is now almost as volatile as the stock market, a very unusual state of affairs for a developed economy.
Chart 1: Three month implied volatility of the sterling/US dollar exchange rate
It’s very hard to know where sterling will be a few months from now. A disruptive No Deal Brexit could see the pound weaken much further. On the other hand, a delay in Brexit with increased prospects for a deal, or even a referendum with remaining in the EU as an option, could see the pound recover sharply.
A General Election would create a further layer of uncertainty for sterling. We learnt in 2017 that opinion polls can shift dramatically during an election campaign. There is little prospect for a new deal with the EU under the short timetable currently available so the markets would probably be forced to factor in a No Deal Brexit under a majority Conservative government. A majority Labour government, on the other hand, would usher in a range of market-unfriendly policies. Arguably the pound would rally most on a hung parliament with centre parties including the Liberal Democrats needed to form a government.
Royal London’s multi asset funds are designed to be resilient to a wide range of outcomes, including a No Deal Brexit and a General Election. We invest across a wide range of asset classes, both at home and overseas. Funds designed for investors with a lower appetite for risk have a larger weighting in domestic bonds and cash, which are unlikely to be impacted significantly by swings in the pound. Meanwhile, the growth-seeking part of our funds is divided between global equities, commercial property and commodities. This spread of investments gives us a degree of natural hedging when currency risk is high.
A No Deal scenario would be a shock for the economy and property market, but UK larger companies derive 70% of their revenues overseas and we’d expect equity prices to rise as a weaker pound inflated earnings. Overseas equities and commodity investments would go up through direct translational effects. In a more positive Brexit scenario for the economy, a rise in the pound would probably crimp returns from equities and commodities, but we’d expect surveyors to mark up UK property prices.
We manage our funds dynamically and take shorter term developments into account in our tactical asset allocation. We have been shifting assets away from sterling in our multi asset funds since Theresa May resigned as prime minister as we judged the risk of No Deal would rise under Boris Johnson. We are monitoring events closely in case of political developments that could lead to a short term bounce in the currency.
We are also watching events outside the UK. We are moderately positive on global equities, despite increasing US-China trade frictions, as monetary policy is easing in America and elsewhere and this should boost the world economy in 2020. Within that position, we are broadly neutral on the UK market where attractive valuations already reflect heightened political uncertainty.
Head of Multi Asset at Royal London Asset Management
Trevor Greetham is a portfolio manager at Royal London Asset Management. Prior to joining Royal London in 2015, Trevor was asset allocation director for Fidelity Worldwide Investment, where he was responsible for implementing tactical investment decisions across a wide range of institutional and retail funds including the Fidelity Multi Asset Strategic Fund.