Sive Morten
Special Consultant to the FPA
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- 18,639
In recent few weeks I've got a lot of requests to make an update on Pound Sterling. Indeed, it is pretty much time passed since we've prepared weekly report about GBP. Supposedly it was somewhere in January or even December. The point is, guys, that we do not escape GBP analysis intentionally, but we need practical component of particular trades that we could do, based on our analysis. If we do not have them - it would be analysis just to prepare it, without practical application. Currently situation has not changed significantly, but still, if you would like to, lets take a look at GBP this time.
Fundamentals
As you will see it below, GBP economy performance doesn't show impressive pace right now. Risks of Brexit still stand on the table because it is too few time passed and the impact on service, financial and banking sector yet to be assessed. Statistics that we're getting today shows that situation is improving, but it comes difficult and UK stands behind US and Germany.
At the same time, currently we have more powerful drivers that change the balance. They are vaccination performance and inflation. As you know, in last two months we every time talk on changing situation and that investors watch not on proper driving factors. Those ones that they suppose should still be dominant - now in fact are loosing power and absolutely different ones come on the first stage. This explains why GBP is rising as in relation to EUR as to USD. Big role here belongs to BoE that was able to hold rates in positive area despite all difficulties and now this brings positive effects to the currency. Although before every BoE meeting we hear debates about rates, whether BoE turns them negative - this is just because of the same reasons. People just do not understand where they are. BoE will not turn rates negative anymore. The time is over. It is impossible because of dynamic of interest rates right now - inflation is growing. So you could surely trade against dovish expectations of BoE policy on every rate decision. Additionally, higher interest rates give handicap to BoE to not rise interest rates too early, as reversal process will be smoother and slower.
At the same time, if we correct on long-term perspective, and this is indeed new upside cycle in global economy - GBP rally is temporal as UK lags to US in recovery pace. It means that US will be the first to tight the interest rates policy. Consequently sooner rather than later GBP turns down against USD. At the same time it could keep rising against the EUR as EU has even more difficult situation. All these stuff should happen this year, closer to the autumn. Because it is too few time till the summer, second - summer is quiet and vacation period and markets usually chill down a bit. Thus, autumn becomes most probable period when this could happen and Fed could start change the rhetoric of its policy, if not rising interest rates directly. Mostly it depends of interest rates rally, especially real interest rates.
This is just in two words. Let's take a look at details.
Week overview
Right from the beginning you could see that the driving factors that we've mentioned above - stand a red line through all headlines.
Sterling hit $1.40 against the dollar for the first time in nearly three years on Friday, as analysts continued to bet Britain’s quick pace of vaccinations will lead to an economic rebound from the country’s worst crash in output in 300 years. The pound is the best performing G10 currency this year, up 2.3% against the dollar as investors bet that Britain’s quicker pace of vaccinations will lead to a recovery from the worst annual fall in economic output in three centuries.
“My sense is the vaccine currency label attached to the pound is in part behind the move through $1.40,” said Neil Jones, head of FX sales, financial institutions at Mizuho Bank. Sterling is benefiting from the fact that the currency market is already looking at a “post-COVID world”. The pound is benefiting from its vaccine currency status. Expectations for a more rapid economic recovery are kicking into play”.
The pound has also gained more than 3% against the euro this year, with analysts attributing the single currency’s weakness to the pound as reflective of other European countries’ relatively slower vaccine rollout. On Friday it traded 0.2% lower to the euro at 86.74 pence.
On Monday, UK Prime Minister Boris Johnson is expected to announce the government’s next steps in fighting the coronavirus, which may include plans to take Britain out of its third national lockdown.
“The apparent success of its vaccine campaign notwithstanding, we think that the UK government would err on the side of caution,” said Valentin Marinov, head of G10 FX research at Credit Agricole in London. In turn, this could disappoint FX investors who have been aggressively adding to their GBP longs in anticipation of a more rapid opening up of the UK economy and have pushed the currency into overbought territory.”
Speculators increased their long positions on sterling - bets the currency will increase in value against the dollar - to their highest levels since March 2020 in the week up to last Tuesday, CFTC data shows.
Towards the end of last year, speculators held short positions on the pound as Britain and the EU raced to sign a post-Brexit trade deal. At $1.40, the pound is about 6% shy of $1.4860 - the level it held a day before the result of the 2016 Brexit referendum was announced.
The currency’s fall in the wake of the Brexit vote made imports more expensive, pushing up inflation. Now, the pound’s strength could hurt export-heavy companies that form Britain’s FTSE 100 index, which earn a majority of their revenue in dollars.
British retail sales tumbled in January as non-essential shops went back into lockdown, official data showed. Retail sales volumes slumped by 8.2% compared with December, a far bigger fall than the 2.5% decrease forecast in a Reuters poll of economists and the second largest on record.
“The Brexit issue has disappeared and we’re now focusing on COVID-19 and how hard the UK economy has been hit,” said Niels Christensen, chief analyst, research and risk solutions at Nordea Markets, noting Britain has been hit hardest among OECD countries. We are now looking at a more positive outlook for the UK economy. And even though expectations of a rate cut from the Bank of England have not completely disappeared, the risk for that has definitely diminished.”
Unwinding of short positions from the end of last year has also benefited sterling."
Britain’s coronavirus-ravaged economy suffered its biggest crash in output in more than 300 years in 2020 when it slumped by 9.9%, data showed last week. Still, sterling is the best-performing G10 currency so far this year, up 2% against the dollar, and 2.5% against the euro.
The pound’s outperformance against the euro is attributed by analysts to a slower vaccine roll-out in other European countries.
“While the UK is currently in lockdown and growth this quarter will be negative, the full-year macro-economic backdrop remains strong and inflation contained,” said Caroline Simmons, UK Chief Investment Officer, UBS Global Wealth Management. Expectations of large fiscal stimulus in the United States and an overall negative outlook on the dollar have also boosted the pound/dollar exchange rate”.
Investors betting on a rebound in global growth - known as the reflation trade - have also contributed to sterling’s gains as the currency is considered correlated with growth and risk sentiment.
“Sterling continues to push ahead as the dividend of rapid vaccination and the currency’s relative high beta among the three majors (USD, EUR and JPY) both help in the current reflationary environment,” ING strategists said in a note to clients. We expect the EUR/GBP medium-term valuation gap to continue closing (we estimate EUR/GBP medium-term fair value at 0.82, based on our BEER model) this year and next. But with the GBP showing signs of a modest overvaluation based on our short-term financial fair value model, the pace of near-term appreciation may slow from here.”
Britain has vaccinated 15.6 million people with a first dose against COVID-19 so far, and bets that its tattered economy could reopen quickly bolstered the pound. Still, some analysts voiced caution at moves to value the pound tied to the progress of vaccination programmes.
“I have been a little bit dubious trading the vaccine rollout differential in FX,” said Derek Halpenny, head of research for global markets at MUFG. Would I be selling the euro because it’s behind on vaccine roll-outs? No,” he said, adding that data on hospitalisations and deaths were also important.
Sterling shrugged off data showing British inflation rose a little more than expected in January as the country went back into a coronavirus lockdown.
Prime Minister Boris Johnson is planning a staged exit from the country’s third national lockdown, which began on Jan. 5, with the battered economy returning to work over the next five months. Adding to the upbeat mood, the European Union said it foresees “stable and balanced” relations with Britain’s financial sector once some ground rules for cooperation are agreed next month.
Amid the improved outlook for the economy, sterling has proved to be the most resilient G10 currency versus the greenback, ING strategists said. It is a matter of time when GBP/USD breaks above the 1.40 level,” they told clients in a note.
Tempering the optimism, Bank of England policymaker Michael Saunders said on Thursday that negative interest rates may soon be the best tool for the central bank, and raised the prospect of unemployment taking a long time to return to pre-pandemic levels. (* Don't believe him, LOL).
London’s FTSE 100 fell on Thursday by the most in nearly three weeks as a set of glum earnings reports underscored the impact of the COVID-19 pandemic, while a stronger pound also weighed on the export-heavy index.
“The company (Barclays) got the cold shoulder from the market as attention was drawn by large provisions on Covid-related bad debt and a warning of a continuing impact through the course of 2021,” said Russ Mould, investment director at AJ Bell.
The FTSE 100 has recovered nearly 35% from its March 2020 lows but has been largely range-bound since the beginning of this year as weak corporate earnings undermine hopes of economic growth in the second half of the year.
The U.S. dollar paused on Friday after its biggest loss in 10 days as disappointing U.S. labour market data bruised optimism for a speedy recovery from the COVID-19 pandemic. The greenback continued to buck its traditional role as a safe-harbour currency, falling in sympathy with U.S. stocks overnight after an unexpected increase in weekly jobless claims soured the economic outlook.
The string of soft labour data is weighing on the dollar even as other indicators have shown resilience, and as President Joe Biden's pandemic relief efforts take shape, including a proposed $1.9 trillion spending package.
"The prospect of a massive U.S. fiscal stimulus plus a successful vaccine roll-out are solid arguments to bet on a U.S. recovery this year," Rodrigo Catril, senior foreign exchange strategist at National Australia Bank in Sydney, wrote in a client note. But the overnight jobless claims data serve as a reminder of the unevenness of the recovery so far."
Many analyst expect the dollar to weaken over the course of the year as it has traditionally done during times of global economic recovery, though it might take some time to develop.
"It looks to me like there’s some exhaustion in that just-straight global reflation theme," leading the dollar to trend largely sideways for now, said Daniel Been, head of FX at ANZ in Sydney. The trade should reignite once fiscal stimulus starts to kick in and services start to reopen in a more fulsome way, he said. We see it broadly as a dollar-negative story," he said.
Thus, the British pound has become an unexpected currency market poster child for the COVID-19 recovery theme. It has marked a major milestone in hitting $1.40, a near three-year high. But just two months ago it was mired in Brexit risks and the worst economic outcome of any major industrialised country. Since mid-December, sterling has strengthened by around 5.5% against the dollar and by 6.5% versus the euro as Britain’s vaccination programme got off to a flying start. Hopes of an earlier end to lockdowns have lifted it 2% against the dollar in February.
Some consider the pound expensive. A Reuters poll predicted the U.S. economy would recover to pre-pandemic levels within a year but saw Britain taking twice that time. There’s also the question of whether the Bank of England might take interest rates negative. Money markets expect it will, though not before the second half of 2022.
Vaccination
With the UK vaccination programme now having passed the government’s target of offering initial doses to the highest priority groups (over-seventies, clinically extremely vulnerable and frontline workers), focus is now turning towards the pace at which lockdowns are likely to be relaxed. As health officials are keen to stress, these decisions will be based on the spread of the disease as well as vaccine coverage. Reassuringly, both of these measures are currently moving in the right direction. Fathom’s central scenario remains optimistic, with a sharp recovery in output likely over the course of the year. A handful of countries have already recovered their pre-crisis levels. Based on the official data, the likes of Ireland, New Zealand and China managed to do this within one quarter of the relaxation of restrictions.
Interest rates and inflation
Higher U.S. Treasury yields have so far done little more than jolt equity markets off record highs. That will change if “real” yields -- adjusted for inflation -- take off. It was last year’s real yield plunge which sent cash flooding into stocks; while expensive, they looked like a good deal compared with real yields of minus 1%.
But big-time government spending plans and prospects of economic reopening have lifted real 30-year Treasury yields to eight-month highs, just 11 basis points shy of 0%. Ten-year real yields are at five-week peaks.
There’s little consensus on when yields will become a problem for equities. But some assets are already seeing an impact -- gold for instance struggles to compete with income-bearing investments when yields rise and is down 6% this year.
Inflation fell sharply during the early stages of the Covid-19 pandemic, with the US Personal Consumption Expenditure measure troughing at 0.5% on a twelve-month basis in April 2020, before recovering to 1.3% at present. Many economists expect it to rise further over coming quarters helped by higher energy prices. Initially, investors in fixed income markets viewed the pandemic as overwhelmingly deflationary, at times pricing in sub-1% US CPI inflation on average over the next five years (chart below). Fathom consulting was always sceptical that this was the correct response, and indeed have been warning clients since 2020 Q3 of a meaningful upside risk to inflation as substantial household savings balances, a consequence of generous fiscal support packages in the major economies, are at least partly unwound. Investors have since moved towards our way of thinking, with market-implied measures of expected inflation moving rapidly back towards target. If there were an unwelcome spike in inflation, there is a risk that the Fed may have to rein in some of its policy accommodation – and/or financial markets may abruptly discount a higher risk premium on government bonds and other financial assets.
In the UK, the supply of so-called ‘high-powered money’ (which includes reserves held at the Bank of England) has increased by some 15% of GDP as a result of the pandemic. That increase in high-powered money was nearly three times as large, as a share of GDP, as the entire stock of high-powered money as recently as 2006. This would matter if there were grounds for thinking that the stock of high-powered money had some systematic relationship with aggregate demand or with inflation. But such relationships as ever existed were bulldozed by the GFC and have now been steamrollered by COVID.
As a result of these brutal (though, on this occasion anyway, necessary) policy interventions, many of the old nostrums of monetary economics have been shattered. ‘Inflation is always and everywhere a monetary phenomenon.’ Is it? When? Where? Despite these record-breaking monetary injections, there is no sign of rising inflation in core prices across the developed world as yet. In fact, core inflation has fallen in most countries thanks to the steepest global recession of all time.
Fathom’s view from the beginning was that the medium-term impact of the crisis would be, if anything, inflationary. That is because, eventually, aggregate demand would come all the way back to where it otherwise would have been, while aggregate supply would remain persistently lower thanks to the impact of the disease on investment and on global supply chains. Early on, bond markets disagreed with that assessment, with even the thirty-year inflation expectation embedded in bond markets falling sharply. But those expectations have since recovered and now stand slightly higher than they were, at all maturities, ahead of the crisis. Bond markets see inflation coming, if only modestly for now. Fathom would agree.
UK economy situation
In the first five weeks of 2021, visits of cargo ships and tankers to UK ports were down by almost 20% on the corresponding period of 2020. It is also visible in the PMI survey of UK manufacturers, which shows a dramatic lengthening of delivery times, second only to that seen last April in the opening stages of the pandemic.
Based on a range of surveys, the Bank of England concluded in its November Monetary Policy Report that traders representing around 30% of UK exports to the EU were not ready for the changes implemented at the end of the year, and that this by itself would temporarily reduce the level of UK GDP in 2021 Q1 by 1%. With COVID-related lockdowns across the four nations affecting economic activity at the same time, it may be hard to identify precisely the impact of short-term, Brexit-related disruptions. Fathom own forecast, for what it is worth, is that the UK economy will contract by around 4% in the first three months of this year.
The UK joined the EEC – the forerunner of what is now the EU – in January 1973. In the following two years, UK trade as a share of GDP rose by more than a third. Fathom estimates that, if one half of this increase were to unwind, the resulting reduction in productivity would leave UK GDP some 2%-3% lower than it would have been otherwise after five years.
Looking ahead, it will be important to monitor the relative performance of the UK and the EU-27 economies to judge the potential impact on UK productivity of the reduction in trade that is likely to follow its decision to leave the EU. Since the 2016 referendum, the EU-27 economies have tended to grow slightly quicker than the UK. Additionally, the UK has suffered a more severe GDP slump during the 2020 pandemic.
And, to better discern the potential socio-economic implications of a potential Brexit-related trade shock, Fathom’s latest quarterly forecast highlighted those industry sectors that export a particularly large share of their output to the EU. As our chart shows, it is the manufacturing sectors, including food and clothing, and financial services, that appear most vulnerable. By region, these activities are concentrated in the Midlands and the North West of England, and in the City of London and Canary Wharf. For an example of how much frictionless trade matters to the UK, one need only read Thursday’s headlines of EU-based banks being unable to trade via London to buy EU shares, resulting in a substantial loss of fees for the City of London.
COT Report
Recent data shows minor bullish changes in net position as investors have closed some shorts on a background of rising of open interest. At the same time, what is more important here is the tendency. Take a look that net long position has started to rise even before agreement has been met and this tendency lasting since the mid December. COT data shows that it is pretty a lot of room till the overbought condition and net longs could rise more.
Source: cftc.gov
Charting by Investing.com
So, as you can see, guys, there are too many factors that impact GBP value. Let's try to structure them and create a picture of most probable GBP performance based on fundamental factors. Also we need recall few our thought on USD value that might help.
Fundamentals
As you will see it below, GBP economy performance doesn't show impressive pace right now. Risks of Brexit still stand on the table because it is too few time passed and the impact on service, financial and banking sector yet to be assessed. Statistics that we're getting today shows that situation is improving, but it comes difficult and UK stands behind US and Germany.
At the same time, currently we have more powerful drivers that change the balance. They are vaccination performance and inflation. As you know, in last two months we every time talk on changing situation and that investors watch not on proper driving factors. Those ones that they suppose should still be dominant - now in fact are loosing power and absolutely different ones come on the first stage. This explains why GBP is rising as in relation to EUR as to USD. Big role here belongs to BoE that was able to hold rates in positive area despite all difficulties and now this brings positive effects to the currency. Although before every BoE meeting we hear debates about rates, whether BoE turns them negative - this is just because of the same reasons. People just do not understand where they are. BoE will not turn rates negative anymore. The time is over. It is impossible because of dynamic of interest rates right now - inflation is growing. So you could surely trade against dovish expectations of BoE policy on every rate decision. Additionally, higher interest rates give handicap to BoE to not rise interest rates too early, as reversal process will be smoother and slower.
At the same time, if we correct on long-term perspective, and this is indeed new upside cycle in global economy - GBP rally is temporal as UK lags to US in recovery pace. It means that US will be the first to tight the interest rates policy. Consequently sooner rather than later GBP turns down against USD. At the same time it could keep rising against the EUR as EU has even more difficult situation. All these stuff should happen this year, closer to the autumn. Because it is too few time till the summer, second - summer is quiet and vacation period and markets usually chill down a bit. Thus, autumn becomes most probable period when this could happen and Fed could start change the rhetoric of its policy, if not rising interest rates directly. Mostly it depends of interest rates rally, especially real interest rates.
This is just in two words. Let's take a look at details.
Week overview
Right from the beginning you could see that the driving factors that we've mentioned above - stand a red line through all headlines.
Sterling hit $1.40 against the dollar for the first time in nearly three years on Friday, as analysts continued to bet Britain’s quick pace of vaccinations will lead to an economic rebound from the country’s worst crash in output in 300 years. The pound is the best performing G10 currency this year, up 2.3% against the dollar as investors bet that Britain’s quicker pace of vaccinations will lead to a recovery from the worst annual fall in economic output in three centuries.
“My sense is the vaccine currency label attached to the pound is in part behind the move through $1.40,” said Neil Jones, head of FX sales, financial institutions at Mizuho Bank. Sterling is benefiting from the fact that the currency market is already looking at a “post-COVID world”. The pound is benefiting from its vaccine currency status. Expectations for a more rapid economic recovery are kicking into play”.
The pound has also gained more than 3% against the euro this year, with analysts attributing the single currency’s weakness to the pound as reflective of other European countries’ relatively slower vaccine rollout. On Friday it traded 0.2% lower to the euro at 86.74 pence.
On Monday, UK Prime Minister Boris Johnson is expected to announce the government’s next steps in fighting the coronavirus, which may include plans to take Britain out of its third national lockdown.
“The apparent success of its vaccine campaign notwithstanding, we think that the UK government would err on the side of caution,” said Valentin Marinov, head of G10 FX research at Credit Agricole in London. In turn, this could disappoint FX investors who have been aggressively adding to their GBP longs in anticipation of a more rapid opening up of the UK economy and have pushed the currency into overbought territory.”
Speculators increased their long positions on sterling - bets the currency will increase in value against the dollar - to their highest levels since March 2020 in the week up to last Tuesday, CFTC data shows.
Towards the end of last year, speculators held short positions on the pound as Britain and the EU raced to sign a post-Brexit trade deal. At $1.40, the pound is about 6% shy of $1.4860 - the level it held a day before the result of the 2016 Brexit referendum was announced.
The currency’s fall in the wake of the Brexit vote made imports more expensive, pushing up inflation. Now, the pound’s strength could hurt export-heavy companies that form Britain’s FTSE 100 index, which earn a majority of their revenue in dollars.
British retail sales tumbled in January as non-essential shops went back into lockdown, official data showed. Retail sales volumes slumped by 8.2% compared with December, a far bigger fall than the 2.5% decrease forecast in a Reuters poll of economists and the second largest on record.
“The Brexit issue has disappeared and we’re now focusing on COVID-19 and how hard the UK economy has been hit,” said Niels Christensen, chief analyst, research and risk solutions at Nordea Markets, noting Britain has been hit hardest among OECD countries. We are now looking at a more positive outlook for the UK economy. And even though expectations of a rate cut from the Bank of England have not completely disappeared, the risk for that has definitely diminished.”
Unwinding of short positions from the end of last year has also benefited sterling."
Britain’s coronavirus-ravaged economy suffered its biggest crash in output in more than 300 years in 2020 when it slumped by 9.9%, data showed last week. Still, sterling is the best-performing G10 currency so far this year, up 2% against the dollar, and 2.5% against the euro.
The pound’s outperformance against the euro is attributed by analysts to a slower vaccine roll-out in other European countries.
“While the UK is currently in lockdown and growth this quarter will be negative, the full-year macro-economic backdrop remains strong and inflation contained,” said Caroline Simmons, UK Chief Investment Officer, UBS Global Wealth Management. Expectations of large fiscal stimulus in the United States and an overall negative outlook on the dollar have also boosted the pound/dollar exchange rate”.
Investors betting on a rebound in global growth - known as the reflation trade - have also contributed to sterling’s gains as the currency is considered correlated with growth and risk sentiment.
“Sterling continues to push ahead as the dividend of rapid vaccination and the currency’s relative high beta among the three majors (USD, EUR and JPY) both help in the current reflationary environment,” ING strategists said in a note to clients. We expect the EUR/GBP medium-term valuation gap to continue closing (we estimate EUR/GBP medium-term fair value at 0.82, based on our BEER model) this year and next. But with the GBP showing signs of a modest overvaluation based on our short-term financial fair value model, the pace of near-term appreciation may slow from here.”
Britain has vaccinated 15.6 million people with a first dose against COVID-19 so far, and bets that its tattered economy could reopen quickly bolstered the pound. Still, some analysts voiced caution at moves to value the pound tied to the progress of vaccination programmes.
“I have been a little bit dubious trading the vaccine rollout differential in FX,” said Derek Halpenny, head of research for global markets at MUFG. Would I be selling the euro because it’s behind on vaccine roll-outs? No,” he said, adding that data on hospitalisations and deaths were also important.
Sterling shrugged off data showing British inflation rose a little more than expected in January as the country went back into a coronavirus lockdown.
Prime Minister Boris Johnson is planning a staged exit from the country’s third national lockdown, which began on Jan. 5, with the battered economy returning to work over the next five months. Adding to the upbeat mood, the European Union said it foresees “stable and balanced” relations with Britain’s financial sector once some ground rules for cooperation are agreed next month.
Amid the improved outlook for the economy, sterling has proved to be the most resilient G10 currency versus the greenback, ING strategists said. It is a matter of time when GBP/USD breaks above the 1.40 level,” they told clients in a note.
Tempering the optimism, Bank of England policymaker Michael Saunders said on Thursday that negative interest rates may soon be the best tool for the central bank, and raised the prospect of unemployment taking a long time to return to pre-pandemic levels. (* Don't believe him, LOL).
London’s FTSE 100 fell on Thursday by the most in nearly three weeks as a set of glum earnings reports underscored the impact of the COVID-19 pandemic, while a stronger pound also weighed on the export-heavy index.
“The company (Barclays) got the cold shoulder from the market as attention was drawn by large provisions on Covid-related bad debt and a warning of a continuing impact through the course of 2021,” said Russ Mould, investment director at AJ Bell.
The FTSE 100 has recovered nearly 35% from its March 2020 lows but has been largely range-bound since the beginning of this year as weak corporate earnings undermine hopes of economic growth in the second half of the year.
The U.S. dollar paused on Friday after its biggest loss in 10 days as disappointing U.S. labour market data bruised optimism for a speedy recovery from the COVID-19 pandemic. The greenback continued to buck its traditional role as a safe-harbour currency, falling in sympathy with U.S. stocks overnight after an unexpected increase in weekly jobless claims soured the economic outlook.
The string of soft labour data is weighing on the dollar even as other indicators have shown resilience, and as President Joe Biden's pandemic relief efforts take shape, including a proposed $1.9 trillion spending package.
"The prospect of a massive U.S. fiscal stimulus plus a successful vaccine roll-out are solid arguments to bet on a U.S. recovery this year," Rodrigo Catril, senior foreign exchange strategist at National Australia Bank in Sydney, wrote in a client note. But the overnight jobless claims data serve as a reminder of the unevenness of the recovery so far."
Many analyst expect the dollar to weaken over the course of the year as it has traditionally done during times of global economic recovery, though it might take some time to develop.
"It looks to me like there’s some exhaustion in that just-straight global reflation theme," leading the dollar to trend largely sideways for now, said Daniel Been, head of FX at ANZ in Sydney. The trade should reignite once fiscal stimulus starts to kick in and services start to reopen in a more fulsome way, he said. We see it broadly as a dollar-negative story," he said.
Thus, the British pound has become an unexpected currency market poster child for the COVID-19 recovery theme. It has marked a major milestone in hitting $1.40, a near three-year high. But just two months ago it was mired in Brexit risks and the worst economic outcome of any major industrialised country. Since mid-December, sterling has strengthened by around 5.5% against the dollar and by 6.5% versus the euro as Britain’s vaccination programme got off to a flying start. Hopes of an earlier end to lockdowns have lifted it 2% against the dollar in February.
Some consider the pound expensive. A Reuters poll predicted the U.S. economy would recover to pre-pandemic levels within a year but saw Britain taking twice that time. There’s also the question of whether the Bank of England might take interest rates negative. Money markets expect it will, though not before the second half of 2022.
Vaccination
With the UK vaccination programme now having passed the government’s target of offering initial doses to the highest priority groups (over-seventies, clinically extremely vulnerable and frontline workers), focus is now turning towards the pace at which lockdowns are likely to be relaxed. As health officials are keen to stress, these decisions will be based on the spread of the disease as well as vaccine coverage. Reassuringly, both of these measures are currently moving in the right direction. Fathom’s central scenario remains optimistic, with a sharp recovery in output likely over the course of the year. A handful of countries have already recovered their pre-crisis levels. Based on the official data, the likes of Ireland, New Zealand and China managed to do this within one quarter of the relaxation of restrictions.
Interest rates and inflation
Higher U.S. Treasury yields have so far done little more than jolt equity markets off record highs. That will change if “real” yields -- adjusted for inflation -- take off. It was last year’s real yield plunge which sent cash flooding into stocks; while expensive, they looked like a good deal compared with real yields of minus 1%.
But big-time government spending plans and prospects of economic reopening have lifted real 30-year Treasury yields to eight-month highs, just 11 basis points shy of 0%. Ten-year real yields are at five-week peaks.
There’s little consensus on when yields will become a problem for equities. But some assets are already seeing an impact -- gold for instance struggles to compete with income-bearing investments when yields rise and is down 6% this year.
Inflation fell sharply during the early stages of the Covid-19 pandemic, with the US Personal Consumption Expenditure measure troughing at 0.5% on a twelve-month basis in April 2020, before recovering to 1.3% at present. Many economists expect it to rise further over coming quarters helped by higher energy prices. Initially, investors in fixed income markets viewed the pandemic as overwhelmingly deflationary, at times pricing in sub-1% US CPI inflation on average over the next five years (chart below). Fathom consulting was always sceptical that this was the correct response, and indeed have been warning clients since 2020 Q3 of a meaningful upside risk to inflation as substantial household savings balances, a consequence of generous fiscal support packages in the major economies, are at least partly unwound. Investors have since moved towards our way of thinking, with market-implied measures of expected inflation moving rapidly back towards target. If there were an unwelcome spike in inflation, there is a risk that the Fed may have to rein in some of its policy accommodation – and/or financial markets may abruptly discount a higher risk premium on government bonds and other financial assets.
In the UK, the supply of so-called ‘high-powered money’ (which includes reserves held at the Bank of England) has increased by some 15% of GDP as a result of the pandemic. That increase in high-powered money was nearly three times as large, as a share of GDP, as the entire stock of high-powered money as recently as 2006. This would matter if there were grounds for thinking that the stock of high-powered money had some systematic relationship with aggregate demand or with inflation. But such relationships as ever existed were bulldozed by the GFC and have now been steamrollered by COVID.
As a result of these brutal (though, on this occasion anyway, necessary) policy interventions, many of the old nostrums of monetary economics have been shattered. ‘Inflation is always and everywhere a monetary phenomenon.’ Is it? When? Where? Despite these record-breaking monetary injections, there is no sign of rising inflation in core prices across the developed world as yet. In fact, core inflation has fallen in most countries thanks to the steepest global recession of all time.
Fathom’s view from the beginning was that the medium-term impact of the crisis would be, if anything, inflationary. That is because, eventually, aggregate demand would come all the way back to where it otherwise would have been, while aggregate supply would remain persistently lower thanks to the impact of the disease on investment and on global supply chains. Early on, bond markets disagreed with that assessment, with even the thirty-year inflation expectation embedded in bond markets falling sharply. But those expectations have since recovered and now stand slightly higher than they were, at all maturities, ahead of the crisis. Bond markets see inflation coming, if only modestly for now. Fathom would agree.
UK economy situation
In the first five weeks of 2021, visits of cargo ships and tankers to UK ports were down by almost 20% on the corresponding period of 2020. It is also visible in the PMI survey of UK manufacturers, which shows a dramatic lengthening of delivery times, second only to that seen last April in the opening stages of the pandemic.
Based on a range of surveys, the Bank of England concluded in its November Monetary Policy Report that traders representing around 30% of UK exports to the EU were not ready for the changes implemented at the end of the year, and that this by itself would temporarily reduce the level of UK GDP in 2021 Q1 by 1%. With COVID-related lockdowns across the four nations affecting economic activity at the same time, it may be hard to identify precisely the impact of short-term, Brexit-related disruptions. Fathom own forecast, for what it is worth, is that the UK economy will contract by around 4% in the first three months of this year.
The UK joined the EEC – the forerunner of what is now the EU – in January 1973. In the following two years, UK trade as a share of GDP rose by more than a third. Fathom estimates that, if one half of this increase were to unwind, the resulting reduction in productivity would leave UK GDP some 2%-3% lower than it would have been otherwise after five years.
Looking ahead, it will be important to monitor the relative performance of the UK and the EU-27 economies to judge the potential impact on UK productivity of the reduction in trade that is likely to follow its decision to leave the EU. Since the 2016 referendum, the EU-27 economies have tended to grow slightly quicker than the UK. Additionally, the UK has suffered a more severe GDP slump during the 2020 pandemic.
And, to better discern the potential socio-economic implications of a potential Brexit-related trade shock, Fathom’s latest quarterly forecast highlighted those industry sectors that export a particularly large share of their output to the EU. As our chart shows, it is the manufacturing sectors, including food and clothing, and financial services, that appear most vulnerable. By region, these activities are concentrated in the Midlands and the North West of England, and in the City of London and Canary Wharf. For an example of how much frictionless trade matters to the UK, one need only read Thursday’s headlines of EU-based banks being unable to trade via London to buy EU shares, resulting in a substantial loss of fees for the City of London.
COT Report
Recent data shows minor bullish changes in net position as investors have closed some shorts on a background of rising of open interest. At the same time, what is more important here is the tendency. Take a look that net long position has started to rise even before agreement has been met and this tendency lasting since the mid December. COT data shows that it is pretty a lot of room till the overbought condition and net longs could rise more.
Source: cftc.gov
Charting by Investing.com
So, as you can see, guys, there are too many factors that impact GBP value. Let's try to structure them and create a picture of most probable GBP performance based on fundamental factors. Also we need recall few our thought on USD value that might help.
