Confessions of a
nervous sterling bull in Dubai!
Matein Khalid
The epic political dramas of last week (Aunty
Theresa’s Brexit plan was rejected by the House of Commons but she managed to
survive a no-confidence vote by a narrow margin) strengthened the British
pound, exactly as I had expected. Yet sterling has not managed to rise above
1.30 to the US dollar in the past two months and now trades at its lowest
levels in the Bretton Woods era of floating exchange rate, apart from 1984 –
85, when a surge in the Reagan dollar and Arthur Scargill’s miners strike led
cable to plunge to almost parity against the greenback.
I still contend that a delay in Article 50 is
inevitable and will lead to a stronger sterling against both the US dollar and
the Euro – at least for the proximate future. By any criteria of purchasing
power parity or inflation/interest rate differentials, sterling is deeply
undervalued against the US dollar, even though two-year US Treasury bond yields
are significantly higher than two-year UK gilts because, unlike the Powell Fed,
Mark Carney’s Bank of England cannot raise its policy rate as long as Brexit
lingers like a macroeconomic sword of Damocles over Britain.
It is also undeniable that the protracted, toxic
politics of the Brexit has led to an increased risk premium on sterling assets as
Westminster has lost its former allure of political stability. After all, the
banking grandees of the City of London are as clueless about the next twist in
the Brexit saga as the currency gnomes of Planet Forex and their acolytes in
the Arabian desert.
It is suicidal to trade on even the most
sophisticated econometric valuation model in the foreign exchange market but The
Economist Big Mac index of purchasing power parity suggests the British pound
is now 27% undervalued against the US dollar. This reflects the exodus of
global investors from sterling and UK risk assets amid the political and
economic uncertainties of Brexit, history’s most draconian economic own goal.
Sterling at 1.30 means Planet Forex disses the
probability of a no deal hard Brexit, anathema to the political elites of
Westminster and the financial elites of the Square Mile. The cognoscenti’s consensus
in the City is for a Norwegian style Brexit. Technicals (slow stochastics)
suggest sterling is overbought at 1.2990 and positioning data/FX options risk
reversal all suggest traders fear downside risk. Jolly good. This only
reinforces my contrarian bullish sterling call. In retrospect, 1.2700 was an
ideal level to accumulate cable as the world enters “Davos week”! After all,
sterling is 100 pips higher in a week in which an incumbent Tory Prime Minister
suffered the most crushing defeat in a parliamentary vote in Westminster since
the 1920s.
The only rational conclusion is that the financial
markets now equate a delay in the March 29 deadline to an ultimately gentler,
softer Brexit. If Britain adopts the Norwegian model in its divorce from the EU,
the sterling bears will be short squeezed with a vengeance as the British pound
surges higher to my next near-term strategic target of 1.36. If history decrees
a second referendum and no Brexit, I can envisage sterling as high as 1.45 –
1.50, a target still below its levels in the 2010 – 2016 Cameron era. Note that
UK inflation has begun to accelerate to 2.1% even as High Street retail sales
had the worst Christmas since 2008, when UK PLC’s biggest banking empires were
technically insolvent. The protracted US Federal government shutdown, the risk
of Presidential impeachment, dystopian political polarization in Washington and
dovish smoke signals from the Presidents of the New York, Chicago, St. Louis
and Atlatic regional Federal Reserve banks suggest that the near-term path of
least resistance for cable is higher despite all the political pantomimes in
the sceptered isle.
It horrified me to see 118 Conservative MPs vote against Prime Minister May in the most important parliamentary vote since World War II. The Tories have been divided over Europe for a generation and Europe schisms ended the political careers of Mrs. Thatcher, John Major and David Cameron. Mrs. May leads a minority government and if her government disintegrates, a general election could well follow – a scenario that could propel Labour’s Jeremy Corbyn into 10 Downing Street. If this happens, all bets are off for sterling and the UK home price fall would morph into an ugly meltdown. (IPA Service)
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