This blog was started nearly a month ago, and it was intended to rehash the argument that the balance of risk for GBP remained on the downside, even after Cable set a new all-time low near $1.0380 (Refinitiv data). Since the EU referendum in 2016 saw the ‘Leave’ side win, my worry has been that Cable would sink to test the $1.0520 area all-time low from 1985. One of the big mistakes that economists made ahead of the referendum was to think that the Bank of England would raise interest rates in the aftermath of a ‘Leave’ vote in order to protect the GBP and avoid inflation pressures. The Bank of England stepped aside (besides offering support to banks if they needed it) though, and the GBP sank from the $1.50 level touched on referendum eve, and has not achieved this level since.
At Tricio we look at FX markets as being a relatively decent reflection of reality. Central banks can support equity, credit and bond markets directly as needed. Currency markets seem to be too big to boss around for long, and unless a country imposes currency controls the FX rate will reflect current interest rate differentials and more importantly, sentiment about expectations about interest rates, economic growth, inflation, trade and capital flows.
The soft GBP since the EU referendum is in my view a reflection that ‘nobody in charge cares about the GBP’. Many in government seem to view a soft Cable rate as being good for exports, and don’t seem to understand that a super soft GBP can deter foreign investment if the view is that it will fall further. Why would a US firm put a few billion GBP into the UK if their accountants will write it down to nearly half that value within two decades, just because the GBP fell? This has been the case for any USD investor putting money into the UK when Cable was above $2.0 in 2007. My gloomiest of forecasts was for Cable to fall towards $0.45 if we treated the break lower from $1.50 as the start of a 70% or so emerging market-like collapse. A ‘technical’ target comes from the break of the flat ‘purple line’ on the long term chart (below). This would point to $0.75/$0.60 sort of targets, based on how you measure the breakpoints.
These targets remain in place, but keep in mind that 1) GBP is not an emerging market currency, yet and 2) there is a chance that someday the UK government will care about the soft GBP and take steps that firm it. This doesn’t mean that they will bid to join the EU again, as the simplest way to give GBP some legs. But who knows, a combination of sensible policies that boost growth and productivity could have foreign investors thinking that a cheap GBP should galvanize them to invest in the UK. Interest rate support? GBP has ‘usually’ had a decent spread over USD short rates, giving it some support. This has disappeared for some time, and may remain the case in the near future. But, over the course of this rate hike cycle, who knows, maybe GBP rates will match USD rates again, or push a bit above them.
Back to the charts and the medium term view (below) shows that the brief break below $1.0520 could have reversal implications. A turn to new lows ‘should have’ seen follow through losses. We haven’t seen that (yet). If the $1.14/1.15 area (horizontal red line) and the 13-week moving average (same area, red line) can be regained, then a push towards the 50-week moving average (blue line) may follow.
The short term chart (below) shows this nicely, and the natural target for a bounce would be the $1.35/1.43 lines (purple and black horizontal lines). Regaining the psychologically important $1.50 level, last seen on EU referendum eve, would be the magic area for GBP longs to regain in order to set sights on $1.75 and higher. Distant dreams? Keep in mind that the soft GBP is one side of the Cable coin. The strong USD has ‘come a long way, baby’, and there should be a decent chance for a ‘mean reversion’ recovery in GBP. Technically, watch the green and red horizontal lines to see if a push either way can build. After being bearish for so long, it will take time to fully embrace the long side of Cable, see if some chart confirmation can be forthcoming.
Gerry Celaya
Chief Strategist