Brexit has been a game-changer for currency watchers, dividing banks and propelling the pound to historic lows. Does a new world mean a new normal for sterling? Matthew Hardeman reports
Sterling has avoided some of the direr projections made in the immediate aftermath of Brexit, moving towards tepid recovery from near-all-time lows – so far, at least. But uncertainty lingers: the currency remains far below its long-term average and record speculative positions are shorted against it.
Others have dissented from the prevailing pessimism, thanks to stronger-than-expected UK economic data and continuing discussion of rising interest rates. They argue the pound is mispriced, and that markets have misinterpreted the impact of Brexit – marking an unusual discrepancy in City thinking. So what is the new normal for sterling?
HSBC is a leading proponent of the speculators’ vision of a weaker currency, forecasting a toxic climate of mounting political risk, structural headwinds in the current account deficit and signs of a softening economic cycle. Deutsche Bank is also bearish, suggesting that sterling could slide a further 15 per cent against the dollar by year’s end. That’s grim news for Threadneedle Street.
But the speculators’ short stance stands in stark contrast to that taken by a minority including Barclays, which strongly views sterling as a buy against the euro. For the bulls, Article 50 starts to clear the fog around the new UK economy, reducing the uncertainty premium currently priced into the currency and will lead to sustained, albeit volatile, appreciation. While Barclays still sees Brexit as an overall loss for the UK, it doesn’t subscribe to what the bank’s head of forex and emerging markets strategy Martin Barth calls the ‘the extreme worst-case scenario’, as he told The Financial Times this week, forecasting instead that sterling will reach 1.38 against the dollar by this time next year.
Coutts CIO Alan Higgins also stands among the bulls. ‘We go against the prevailing pessimism – it is a little bit lonely, but we are positive,’ he says. He is quick to caveat that currencies are ‘incredibly difficult’ to get right, but the short bets are welcome: ‘Historically that’s a good sign, because when a group of investors gets so short [on currency], there’s only one way to go, which is short covering, and buying it back,’ he says. ‘Sterling is quite a means-reverting currency – it does move around an average, so prospects would be good.’
Higgins adds that the UK economy is holding up well against the backdrop of a ‘pretty strong’ global economy, but if Brexit turns out much worse than people think and there’s no agreement with the EU for two years – or a year goes by without any insight, he expects ‘fear in business and risk-averse behaviour in the UK, which will really undermine the UK economy and sterling.
‘A very, very bad Brexit is certainly possible, but we think a lot of it is in the [current] price and we think there are probably the right people doing the right job to get the best deal for the UK.’
Geoffrey Yu, head of UK investment at UBS Wealth Management, also sees upside, diverging from HSBC and Deutsche’s analysis that the UK needs a weaker currency to make its balance of payments more sustainable. Meanwhile, Yu and fellow bulls believe markets have overly-concentrated on the tail-end risks pricing in a ‘worst-case scenario’ for the UK that is unlikely to bear out. And the state of play during the Brexit negotiations matters less than people think: ‘It’s going to be important, but we focus more on the underlying performance in the UK economy at that point.’
The dollar may be a bit too expensive – and that’s good news for the pound: ‘Our view is that there is plenty of upside potential and that we should just go from there,’ says the UBS man. ‘It takes two sides to make a market, and if everyone suddenly turns around and wants to buy sterling, maybe then it’s time to do a double-take and say, “Yes we are positive on the currency – but if everyone is long; if everyone owns it – then by definition the next trade is going to be to sell it, right?” That’s perhaps when [sterling] is going to fade.’
The brains over at Charles Stanley also think that sterling is worth betting on. ‘[Our] view is that sterling is towards the bottom end of its trading range against the dollar and the euro,’ says John Redwood, the firm’s chief global strategist. He notes that one pressure on the pound has been the growing interest rate differential with the US: ‘On a longer term basis sterling offers good value, with the UK competitive at these rates.'
Others are keeping their cards closer to their chests (Citi declined to comment on anything Brexit-related). Meanwhile, veteran CIO Jonathan Bell at Stanhope Capital sees some positives in the aftermath of the referendum, like increased bank to bank lending, but takes a more cautious view. He says sterling might be ‘slightly undervalued’ on a PPP basis, ‘but that’s not that useful when you’re looking at where it’s going to go’.
The firm maintains its long-held the view that if the UK left the EU, sterling would drop to 1.30 [against the dollar], but a hard Brexit would plunge the pound to 1.20: ‘Our view has changed little since then in that we’re now looking at a fairly hard Brexit – I can’t see how the negotiations can be anything other than worrying. Because how do you negotiate without starting by telling the other side to give way otherwise you’ll suffer?’
‘We’re likely to get very little good news – and so therefore I can’t see that much upside in the short term,’ (he notes that Stanhope added to its sterling position when it reached 1.20 earlier this year – a figure he doesn’t see the pound falling far below).
One thing is clear: we’re now looking at a positively murky picture moving forwards – and consensus is a long way off. ‘My feeling is that in twenty years’ time it will have been a good decision, but for the next five years, it’s going to lead to weaker growth. For the next two years, I can’t see much good news out of this,’ Bell says.
If he’s right, it’s hard to see the pound occupying the space it used to on currency markets again anytime soon. If others are right – it’s time to buy sterling.
So it looks like the new normal is that we just don’t know.
Matthew Hardeman is deputy head of Spear's Research Unit
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