When the history of Brexit is eventually written, the spring of 2017 may come to be known as a turning point, particularly for the pound.
There is no escaping the reality that sterling is a devalued currency, 14 per cent lower in trade-weighted terms since the vote for Brexit in June.
Yet 2017 has so far seen the pound navigate moments of turbulence without further damage. This week was typical. The pound took a dip on poor manufacturing and construction data, and bounced again after the services sector performed better than expected.
At around $1.2420, sterling remains firmer since the start of the year. “Investors have taken news about Article 50, and there’s been a lot, in their stride,” says Simon Derrick of BNY Mellon.
Such resilience suggests doom-laden predictions of new post-Brexit vote lows may be missing the mark, and moreover that the currency has potential for a significant rebound in the coming months.
1. Theresa May’s “citizens of nowhere” speech leads to start of sterling sell-off
2. Philip Hammond and David Davis meet bank chiefs at the Shard in a “reassurance exercise”
3. May’s Sky TV interview leaves markets unimpressed; pound falls again
4. Sterling retreats after Downing Street briefings on May’s upcoming speech on Brexit
5. May’s Lancaster House Brexit speech contributes to pound’s 3 per cent bounce
6. Bank of England meeting prompts sterling fall
7. Article 50 is triggered, starting a two-year exit negotiation process
That’s the abiding dilemma for investors and companies, particularly those who need to implement currency hedges and protect their portfolios and business revenues from a big swing in the pound over the next year.
And lately, analysts’ sterling forecasts, which had for some months been leaning heavily on the bearish side, have swung towards a bullish outlook.
While the likes of Bank of America Merrill Lynch, Citigroup, HSBC, UBS and Commerzbank have end-of-year forecasts for the pound that fall in a range of $1.10 to $1.20, and Deutsche predicts $1.05, the targets of Barclays, Investec, RBS, Danke and MUFG are somewhere between $1.30 and $1.35.
Their differences can be summed up thus: low forecasts reflect a dislike of Brexit uncertainty, worry about its impact on the UK economy and concern over the UK’s hefty current account deficit.
The basis for thinking sterling can climb beyond $1.30 — a level that was decisively broken at the end of September — reflects a sense that Brexit’s difficulties for the UK are misplaced. What is more, on various measures the pound looks attractive and the underlying strength of the economy is sound.
Sterling certainly looks good value. “The pound is really cheap versus the US dollar on a purchasing power parity basis,” says Marcelle Daher, head of asset allocation for North America at Manulife Asset Management, which invests $350bn.
“Most people are focused on the negative ramifications from Brexit. It’s at a point where it could be interesting, given its deviation from our valuation models.”
According to MUFG, sterling is some 15 per cent below fair value, while Marvin Barth at Barclays says sterling is at the nadir of the 1992 European Exchange Rate Mechanism (ERM) debacle.
“That seems to be excessive for an event that is certainly going to be a hit to the UK economy, but one that will be felt over decades, not in the near term,” Mr Barth says.
Sterling is indeed undervalued, says Jeremy Cook, chief economist of the payments provider World First, but that does not mean it cannot depreciate further.
He says: “Sterling is going to be extremely noisy for the next two years, heightening the chance of an errant statement or misconstrued rumour eliminating value from what could be a profitable longer-term position.”
Sterling is trading in an environment of low volatility, marked by long-term investors reducing short positions rather than traders putting on long positions, as the market worries when exactly the negotiations start.
“The market is still short, still believes risk is to the downside and is struggling to see the next driver,” says Richard Bibbey, head of FX cash trading and risk management at HSBC. He argues that such a trading environment is hardly conducive to a sterling rally.
Of course, the pound could split the difference between the bears and the bulls and carry on holding to the $1.20-$1.30 range that, give or take the odd breakout, has persisted since October.
Yet a look at investors’ screens reveals one glaring reason why this impasse may soon be over. When they look at the pound’s likely path against one of their most commonly used yet dependable trading tools, the simple moving average, they should feel nervous.
When a price breaks through the 50 or 100 or 200-day moving average, that is the moment to change trading strategy. The pound looks ready to break those SMAs, though in different directions.
A drop below the 50 and 100-day SMAs — around $1.2420 — looms large, but one can argue that the pound has its sights on the upside, rising above the more important 200-day SMA — currently around $1.2646.
“Given the big move we’ve had post-Brexit, a break of the 200-day moving average could well get a lot of attention,” says Derek Halpenny at MUFG.
So if the pound is about to find a new level, which way will it go?
The dilemma is one faced by central banks. A survey of 80 reserve managers found nearly half had changed their view of sterling in the short term, yet nearly three-quarters said their long-term view of the currency was unchanged.
Sterling’s depreciation made it less attractive in the short run, said one reserve manager from Asia, but “in the long run, the UK economy is expected to recover with economic fundamentals remaining steady”.
It is perhaps no surprise that this pivotal moment for sterling comes after the triggering of Article 50 and the start of formal negotiations with the EU over Britain’s exit.
“We have never been here before,” says Mr Barth. Theresa May’s “hard Brexit” speech in January and Article 50 were taken as bad news by investors, “but ultimately they are news. And that reduces uncertainty. That is one of the conundrums markets face”.
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