LCG Insight: ‘Heightened risk premia’ on UK assets By Ipek Ozkardeskaya

 

‘Heightened risk premia’ on UK assets

By Ipek Ozkardeskaya

The Bank of England (BoE) released its Financial Stability Report and the UK banks’ stress test results. In his statement, Governor Mark Carney highlighted that there is ‘some evidence of heightened risk premia on UK assets’ and 18-24 months may be needed for the Brexit transition. Carney said, ‘the sooner the better’ for a transitional deal.

Governor Carney’s speech slightly weighed on the pound. As expected, the BoE hawks could hardly find a motive to capitalize on the FPC’s (Financial Policy Committee) statement. Cable’s failure to extend gains above the 1.3383 level (Monday high) could be an early toppish sign and encourage short-term traders to realize profits and move to the sidelines. A downside correction in the GBPUSD could stretch toward the 50-day moving average (1.3250).

The FTSE 100 gave a little reaction to Carney’s statement. Energy stocks (+1.30%) gained despite the downside correction in oil prices, mining stocks (-0.96%) traded at the bottom of the range, as industrial metals slid by nearly 2.5% in two sessions (reference: Bloomberg industrial metals subindex).

Pound traders will also remain sensitive to developments on Brexit negotiations. News that the UK could consider doubling its settlement bill to break the impasse in post-Brexit trade negotiations boosted the pound last week. But there is no official statement from the UK officials yet. Any negative news on this issue could further weigh on the pound’s positive trend.

US Senate’s tax reform vote could be delayed

The US stock markets were flat on Monday. The controversies on the US tax reform bill weighed on the sentiment. According to Bloomberg news, ‘two top members of the Senate’s budget panel might not send the bill for debate today. That would mean plans for a full Senate vote this week would fall through’. A delayed vote could curb the upside momentum in the US stock markets.

This being said, the uncertainties on the US tax reforms didn’t prevent the S&P500 from closing above the $2’600 level for the second session in a row. There is still no sign of anxiety in the market; the VIX index remains below the 10% level. Some traders could find opportunity in buying the price pullbacks. Yet provided that the US stocks trade at historically high levels, we could hardly talk about ‘dip-buying’. On the other hand, buying US stocks at the historical high levels has been a prosperous strategy over the course of the past year. Investors keep their expectations high, but even a ‘phenomenal’ tax reform would not justify a rise in stock valuations endlessly. Buying at the historical high levels represent a risk and this risk increases gradually as the stock prices rise.

What causes the slide in the US yields?

The probability of a December rate hike stands at a solid 95.9%, meaning that the market has almost fully priced in a 25 basis points hike in the US rates before the end of the year. In addition, the future Federal Reserve (Fed) chief Jerome Powell said that the Fed should continue raising rates and reduce the size of its balance sheet gradually under his leadership. His confirmation hearing is due today. The US economic data has been encouraging so far. The core inflation picked up in October after having stagnated for five months. The US third quarter GDP is expected to be revised higher to 3.2% from 3.0% on Wednesday. Looking at the actual picture, the US yields should be edging higher, instead of falling to decade-low levels. There are rumours in the market that the pension funds are adjusting their portfolios in preparation for a positive outcome on the fiscal leg. This means that a delayed Senate vote, and/or a failure to pass the tax bill could halt or reverse the negative trend in the US yields.

Yen, gold gain on renewed N. Korean threat

The yen extended gains versus all of its G10 counterparts on news that North Korea may be preparing a new nuclear missile test. The USDJPY eased to 110.84 on Monday and the downside move could stretch toward the 110.00 level. Solid resistance is eyed at 111.70 (200-day moving average). Put options are waiting to be exercised at this level today.

Gold trades near its daily upper Bollinger band ($1’295). More resistance is eyed at $1’300/1’306 (October high). Two factors could help clearing this resistance. First, a renewed escalation in North Korean crisis could trigger rapid risk-haven inflows into the yellow metal. Second, investors could increase their gold allocations, if the US 10-year yield threatens the critical 2.30% support (200-day moving average).

Ipek Ozkardeskaya

Senior Market Analyst

+4420 7456 7569
ipek.ozkardeskaya@lcg.com
LCG.com

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