Is it time to become bullish on the GBP?

The pound has dropped dramatically against the Euro since Cameron announced his austerity policies — and very wrongly so. Keynesians and Monetarist don't get anything right, and so it's not surprising to hear that these mesures will weaken the economy and the currency. But it's precisely the opposite that is true.

On the sentiment side, it looks like the trade is one-sided, with every player in the market thinking that the pound is due for a collapse, while it reality, it has already collapse, and that deflation will make it's value higher, and not lower.

Here are a few quotes from a Bloomberg report:
Oct. 25 (Bloomberg) -- The only major currency rivaling the dollar’s decline since July is the pound, and foreign-exchange strategists say the worst is yet to come for Britain’s legal tender.

Sterling has depreciated 5.1 percent against a basket of the nine other most-traded currencies, including last week’s 1.29 percent drop. Strategists are the most pessimistic on the pound versus the euro since the ruling Conservative-Liberal Democrat coalition came to power in May, according to data compiled by Bloomberg.

The decline suggests investors are losing confidence in Prime Minister David Cameron’s ability to restore growth while promising the deepest spending reductions in British history to shrink the biggest deficit in the Group of 20. His 81 billion pounds ($128 billion) of cuts through 2015 will force Bank of England Governor Mervyn King to print cash through so-called quantitative easing to prevent a new recession, overwhelming demand for sterling, according to UBS AG.

“There’s definitely more weakness to come,” said Hans- Guenter Redeker, global head of currency strategy in London at BNP Paribas SA. “The fiscal consolidation is going to hit the economy at a time when it’s slowing. Under these conditions, you need to have loose monetary conditions and that weakens the exchange rate.”

UBS[...] recommended on Oct. 21 its clients sell the pound, especially against the Swiss franc, Australian dollar and Norwegian krone. Morgan Stanley strategists said it may weaken to 93 pence per euro from 88.96 pence today should the recovery slow further or Bank of England policy makers signal more credit-easing measures.
The U.K.’s spending cuts are “insane” and the pound will slump to below $1.40 as early as this year, John Taylor, chief executive officer of FX Concepts Inc., told the Telegraph newspaper.
Yet another nonsensical statement by incompetent John R. Taylor. So far in the past, it has always paid for me to bet against him (follow this).
“The U.K.’s fiscal policy is going to be tighter than anyone else’s, and therefore there’s much less reason to expect any tightening of monetary policy even if there is some sort of global recovery,” said Adrian Schmidt, London-based foreign- exchange strategist at Lloyds Banking Group Plc in London. Schmidt said the pound may weaken to 95 pence per euro this year. “The ECB will be raising rates before the BOE,” he said.

“We like the pound relative to the dollar,” said Monica Fan, London-based senior currency strategist at State Street Global Advisors, which oversees $83 billion. “King’s recent statement, which the market took as an endorsement of another round of QE, took a bit of the shine off, but the pound remains undervalued against the dollar and the government’s fiscal consolidation will provide support.”
Monica Fan gets it. Cheerio!
Policy makers may favor a weaker pound to keep Britain’s exports competitive, said Robin Marshall, a director of fixed income at Smith & Williamson Investment Management in London, which oversees about $20 billion.
It looks like sentiment is extremely bearish on the GBP, while actually fundamentals have been improving. This is a positive development for trading the GBP against the EUR, which is in the opposite situation: extreme bullishness, and weaker (compared to where we were 6 months ago) fundamentals.

Full disclosure: no position open yet.

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