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Bearish investor sentiment weighs heavily on sterling

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Abi Oladimeji, Chief Investment Officer at Thomas Miller Investment, provides his current views on the major asset classes, and the possible impact of ongoing uncertainty on sterling…

We continue to believe the balance of macro risks and opportunities warrants a neutral stance on the major asset classes relative to longer term strategic allocation and, therefore, we are maintaining broadly neutral asset allocation positions.
  
Equity markets are caught between the positive effects of robust growth and strong earnings and the negative influence of uncertainties about interest rate outlook and trade policy. Despite providing short term support, the strength in recent earnings growth is not sustainable and the likely decline in earnings growth rates should begin to weigh on expectations for 2019.
 
Strong growth, low unemployment rate and rising inflation mean that the US Federal Reserve is likely to maintain its course of interest rate hikes. Further increases in US interest rates will drive further flattening in the yield curve. The direction of monetary policy has also changed outside the US, with the Bank of England recently raising interest rates while the European Central Bank has announced plans to end quantitative easing. This combination is negative for bonds in general.
 
However, safe haven demand, driven by concerns about the economic impact of a potential trade war and fears about spill over effects from the ongoing crisis in Turkey should provide some support. We remain cautious on corporate bonds across the credit spectrum on the basis that credit spreads remain tight.
  
Following the risk-off period in the first quarter, the alternative assets we invest in have staged a strong recovery. The performance of the listed PPP/PFI Infrastructure sector has been particularly notable as a series of secondary market transactions have supported the notion that underlying portfolios are conservatively valued. Fundamentals also remain strong for other sectors such as digital infrastructure and private equity.
  
The key trend in currency markets looks set to remain that of US Dollar strength against other major currencies as the USD continues to enjoy yield support. Focusing on sterling, the recent slide in the GBP/USD rate has been driven by ongoing Brexit-related uncertainties as investors assess the risk of a no-deal exit from the EU.
 
In the short term, the weight of bearish investor positioning could push GBP much lower than what could be justified on fundamental grounds. Nevertheless, an actual no-deal outcome would most likely result in a far more protracted sterling sell-off, likely pushing sterling below USD1.20. On the other hand, sterling’s sensitivity to Brexit news flow is such that any news of a UK/EU agreement could trigger a sharp relief rally which would be further fuelled by short covering as bearish positions are unwound. It looks set to be a long summer for sterling.

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