Uplift in Global Markets Pulls Pound Sterling Higher, U.S. Fiscal Rescue Package Cheered by Investors

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Above: File image of Senator Mitch McConnell of Kentucky, Senate Majority Leader. Image © Gage Skidmore, Accessed Flickr.

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Global markets have surged higher over the past 24 hours amidst an improvement in global investor sentiment, which has in turn benefited the Pound.

The Pound tends to benefit when markets are rising as it suggests increasingly confident investors are once again dipping their toes into UK-based assets, as foreign capital flows into the UK economy the Pound is bid higher.

Sentiment on Wednesday was boosted by overnight news that U.S. President Donald Trump's administration struck a deal with Senate Democrats and Republicans on a fiscal rescue package that would make available more than $2TRN in spending and tax breaks, aimed at softening the impact of the coronavirus outbreak on the U.S. economy.

"At last we have a deal," Senate Majority Leader Mitch McConnell said following the passing of the deal. "I’m thrilled that we’re finally going to deliver to the country."

The plan will see $500BN made available to back loans and other aid to businesses, the delivery of $1.2K to most citizens and more than $350BN for small businesses to maintain their payrolls.

Unemployment insurance will be beefed up while tax payments will be deferred. "An unprecedented bout of stimulus is helping prop up global equities, with investors hoping to pick up some staple travel firms in the hope of a long-term recovery," says Joshua Mahony, Senior Market Analyst at IG. "We find ourselves in the midst of an unprecedented bout of global fiscal stimulus, there is plenty of good news helping to overshadow the inevitable economic difficulty that lies ahead."

The improved mood music on global markets also follows steps by global central banks to boost their supply of cheap money into the global economy.

Markets rebounded sharply, "encouraged by the Federal Reserve’s decision to expand monetary policy measures to help ease liquidity gaps and credit strains," says Mark Haefele, Chief Investment Officer Global Wealth Management at UBS AG. "The Fed's decision to effectively remove any limits on quantitative easing and establish facilities for the purchase of corporate bonds in the primary and secondary markets, along with support for municipal lenders, represents a significant escalation of its monetary policy support."

The U.S. Federal Reserve on Tuesday pledged to buy a potentially unlimited amount of U.S. government debt and ramp up lending support to businesses in a what is a significant intervention.

“Aggressive efforts must be taken across the public and private sectors to limit the losses to jobs and incomes and to promote a swift recovery once the disruptions abate,” the Fed said in a statement.

The cumulative effect of weeks of Fed actions appears to have now stabilised global dollar funding markets and instilled confidence in markets, allowing a broad-based rally in stocks, commodities and currencies that are deemed to be 'risk on'. This includes the likes of the Australian and New Zealand Dollars, Norway's Krone and Britain's Pound.

FTSE 100 recovery

Above: FTSE 100 performance since October 2019.

The Pound-to-Euro exchange rate put in a low last Thursday when it hit 1.0526 and has since rallied back to 1.0932.

The Pound-to-Dollar exchange rate put in a low of 1.1414 last Friday and has since recovered to 1.1826.

"The British Pound is undervalued. We think it has appreciation potential, particularly against the U.S. Dollar over our tactical investment horizon, if the UK embarks on a fiscal stimulus package. For the longer term, we recommend holding the UK assets in your portfolio unhedged," says Haefele.

Pound Sterling vs. Euro

Above: Sterling recovers against the Euro, in line with an improvement in broader market sentiment

Of course, the sustainability of the current improvement in investor sentiment is by no means assured given that the trajectory of both infections and deaths owing to coronavirus in many of the world's largest and most important economies remains resolutely higher.

The spread of the coronavirus is by no means over and quantifying the overall economic cost and the potential disruption to financial systems remains impossible to quantify.

Therefore, as long as the Pound continues to trade in a reactionary function to broader investment sentiment, we remain wary of the sustainability of the ongoing recovery in both stocks and Sterling.

"The positive reaction in stock markets since the Fed’s extraordinary policy announcement yesterday belies the fact that central bank actions have yet to quell the strains showing up across the global financial system. It is hard to see a lasting recovery in equity prices until those strains subside," says Oliver Jones, Senior Markets Economist at Capital Economics.

We therefore note that while Sterling looks cheap, and will ultimately recover, we would need to see a fundamental shift in the coronavirus narrative.

"With great uncertainty regarding how quickly a vaccine for COVID-19 can be developed, a key downside risk to our medium-term projections is that the virus forces another lockdown next winter. A V-shaped recovery is far from assured," says Samuel Tombs, UK Chief Economist at Pantheon Macroeconomics.

A game-changer for markets would be news of the development of a credible vaccine, but this is only expected to be made available next year.

Moderna Inc. said its experimental vaccine for Covid-19 could be available to a select few as soon as this fall, ahead of expectations for a commercial release in a year.

Stephane Bancel, the biotech’s chief executive, told Goldman Sachs on Friday that mRNA-1273 could be made available to a few, potentially health-care workers, under emergency use authorization, according to a company statement.

However, a number of Governments are also working on a vaccine, including China who will presumably have a head start on other companies and countries; any surprising progress here could prove to be a boon for global investor sentiment and help put a floor under markets, including Sterling.

Short of a vaccine being developed, markets will likely also take heart from signs that the infection and death rates in the major developed economies are flattening out.

An additional positive, and this is quite likely, would be more government's stepping forward with aggressive policy measures aimed at helping their economies weather what will ultimately be a time-limited hit.

"I do not see this as the bottom as what is going on does not represent the reality of the economic situation and so I am still staying out," says independent research analyst Richard Windsor, who specifically covers the technology sector.

Windsor says markets are at danger of a significant dislocation from reality thanks to the decision by the Fed and other central banks to pump trillions of easing money into the global economy.

A jump in share prices over recent days belies the reality that the global economy is in for a severe recession, that will by no means be followed by an economic surge.

"The Fed has said that there are no limits to how much money it will print, and the likelihood is that this bailout will have to be extended beyond investment-grade and government-backed debt in order to prevent the first domino from falling and setting off all the rest," says Windsor.

The former Nomura analyst, who now publishes research on his Radio Free Mobile blog, says central banks such as the Fed are now "printing money and creating liquidity out of thin air".

"The net result is a huge increase in the money supply which has not been backed by any physical asset since 1971," says Windsor.

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