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Uncertainty drives sterling risk metric to ten month high

Fathom Consulting

05 Jul 2017

Tightrope walker Nik Wallenda walks the high wire from the U.S. side to the Canadian side over the Horseshoe Falls in Niagara Falls, Ontario, June 15, 2012. Photographer: Mark Blinch

Last month, Fathom Consulting’s measure of risk priced into sterling markets climbed to its highest level since August last year, driven by UK interest rate and political uncertainty.

The Fathom StRRiM (Sterling Relative Risk Metric) measures risks priced into a variety of sterling markets relative to those seen in other developed markets.

Alongside heightened political uncertainty, the chart from Fathom Consulting highlights the impact of recent speculation regarding the timing of the next move in monetary policy.

As a result, in June, the StRRiM climbed to its highest level since last August, as seen in the chart below.

The Fathom StRRiM (Sterling Relative Risk Metric) chart
The Fathom StRRiM (Sterling Relative Risk Metric) chart

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Carney caution

Following last month’s Bank of England Monetary Policy Committee (MPC) meeting, and the announcement that three MPC members had voted to increase interest rates, we received important speeches from several MPC members.

Britain’s Bank of England Governor, Mark Carney, speaks during the Bank of England’s financial stability report at the Bank of England in the City of London, Britain June 27, 2017. Photographer: Jonathan Brady

First, Governor Mark Carney stated that “now is not yet the time” to begin raising rates.

Indeed, he spoke of wanting to assess evidence “over the coming months”, suggesting that, for now at least, he is not minded to vote for tighter policy any time soon.

The pound fell and short sterling interest rate futures rallied as markets pushed back expectations of an imminent rate rise.

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Rate cut reversal

However, the Bank’s Chief Economist Andy Haldane followed up with a hawkish speech, in which he argued that a reversal of the 25 basis point cut enacted after the Brexit vote last year would be “prudent relatively soon”.

Thomson Reuters Datastream
Thomson Reuters Datastream

Thomson Reuters Datastream allows you to identify and examine trends, generate and test ideas and develop view points on the market

Markets changed course once again, with Carney adding to this momentum when he made a further speech suggesting that interest rates could rise if business investment grows.

As a result, a 25 basis point increase in interest rates by the middle of next year is now fully priced in.

In Fathom’s central view, UK monetary policy is on hold for the foreseeable future.

Nevertheless, Fathom sees a risk that last year’s futile 25 basis point post-referendum cut is reversed.

August speculation

With the UK macroeconomic outlook set to deteriorate through the second half of this year, Fathom believe any modest tightening would need to happen sooner rather than later.

On that basis, August would be the most likely month for a move.

All three major components of StRRiM — foreign exchange, fixed income and equities — are now in positive territory, meaning that relative risk in all sterling markets is higher than the norm.

With Brexit negotiations and the general election result meaning heightened political uncertainty will remain for some time, the metric is likely to be elevated until the outlook for monetary policy is clearer.

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