Pound recovers on Brexit silver lining, as yields and dollar fall

Week of October 13

Last week, we saw US government bonds outperform their European rivals. The 10-year Treasury yield ended the week 9 basis points lower, after bond investors revised their inflation and rate hike expectations downwards. Most still anticipate a 25-basis point rise in December, but Friday’s lower-than-expected increase of 0.1% in the core consumer price index fuelled speculation about fewer and slower rate increases. Concerns over continued low inflation were also shared by the Federal Open Market Committee, as the latest meeting minutes released on Wednesday showed.

The reduced inflation and interest rate forecasts also put downward pressure on the US dollar, which weakened by 0.75% against a basket of major currencies. The pound, in particular, was able to recover by almost 2% versus the greenback. Following a volatile week of conflicting reports on the progress of the Brexit negotiations from both parties, the British currency finally got a 1% boost on Friday after a report in German newspaper Handelsblatt indicated that the European Union could offer Britain a two-year transitional deal. Short-horizon risk for GBP/USD remained at 8.9%, slightly higher than the 8.7% recorded for USD/JPY.

Meanwhile, short-term risk in Axioma’s global multi-asset class model portfolio rebounded to 3.57%, up from 3.05% the week before. The increase occurred despite lower standalone volatilities for both equity and FX factors. However, a significantly reduced negative correlation between the two risk types meant that there was less offset from exchange rate movements across global stock markets. This resulted in a pronounced contraction of the diversification effect from over 5% to just under 4%. The increase in risk contribution was most noticeable for developed non-US equities, where the share of overall risk grew by 0.18%. Non-USD-denominated Treasuries and corporate bonds experienced similar rises of 0.10% and 0.11%, respectively, while Oil saw its volatility-lowering effect reduced, as its interrelationship with foreign currencies strengthened.

Christoph Schon, CFA, CIPM

Christoph Schon is the Executive Director, Applied Research for EMEA at Axioma, where he generates insights into recent risk trends with a particular focus on fixed income and multi-asset class analysis. Christoph has been in the portfolio risk and performance analysis space for more than 10 years, having previously worked for Lehman Brothers/Barclays POINT and UBS Delta.