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Global economy winning tug of war with Brexit over direction of FTSE 100

The pound's negative relationship with U.K. stocks went into overdrive following the 2016 Brexit referendum, with the pound plummeting and FTSE 100 soaring. The dramatically strengthening correlation was short-lived, as the global economy reasserted itself.

Now, the negative correlation is coming back as the U.K. faces yet another Brexit deadline that has whipsawed sterling in recent months.

Despite being U.K.-based, the global footprint of FTSE 100 companies such as Royal Dutch Shell PLC, HSBC Holdings PLC and BP PLC, means some 70% of revenues are generated in dollars. As a result, when the pound weakens, the dollar revenues increase in value, improving the financial performance.

Since 2010, the inverse correlation between the performance of GBP/USD and the FTSE 100 is -0.37, meaning that 37% of the move in the FTSE 100 could be attributed to changes in the value of the pound. But the positive correlation between the FTSE 100 and the S&P 500 is far stronger in that period at 0.92, indicating that the performance of the big U.K. multinationals is much more closely tied to global markets.

"You cannot extract the U.K. from the global system," said Kamal Sharma, director of G10 FX strategy at Bank of America Merrill Lynch. "You cannot say every time sterling falls it's a Brexit story."

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In the immediate aftermath of the referendum of June 24, 2016, the correlation between the fate of U.K. stocks and the pound strengthened, jumping to -0.70 between the result and the end of 2017.

The impact was to send the FTSE 100 soaring. The index gained 16% in the post-referendum period to end 2016 at 7,142.8. Whereas the S&P 500 climbed by 10% by the end of the year, as the correlation between the two indexes fell to 0.62.

The correlation between the two indexes weakened further in 2018, dropping to 54.5, while the FTSE 100 became positively correlated to the GBP/USD, although at just 0.20.

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Historic relationships return in 2019

The correlation between the FTSE 100 and the pound is inverted again at -0.27, but U.K. stocks are much more closely linked with the S&P 500 where the correlation has risen to 0.89.

The inversion of the relationship with sterling had been led by the heightened possibility of a no-deal Brexit, which has seen the pound slump 6.8% from its 2019 high of $1.33 on Feb. 27, to $1.24 at the close of Oct. 3. Stocks have risen in the developed world as yield-hungry investors struggle to find returns in a world of loose monetary policy.

"The FTSE is international but there is still a relationship to the pound. The main correlation should be to the S&P 500," Sharma said.