No one comes to save pounds

It’s a bad day for the pound, even worse than the bad day last week.

© Bloomberg

According to the FT:

The pound fell 0.8 percent in morning trade in London to $1.137, the first time it has breached the $1.14 mark in nearly four decades, according to Refinitiv data. The move reflected broad strength in the dollar as well as particular concern about the state of the UK economy.

Time is a flat circle and this latest slide lands 30 years since Black Wednesday, when the pound plunged as Britain left the European Exchange Rate Mechanism.

Covering this uncanny taste of the benchmark has a habit of producing déjà vu moment: if the cable has a potential resistance point around $1.14, we may see more “new 37-year lows” headlines before things settle down.

The options are a rebound (!!!), or that the pound is now entering some kind of persistent death spiral, meaning it won’t continue to get flashy “worst since” headlines as it heads towards the 1985 lows. It is a relief for financial journalists (🎻👌), and exactly no one else.

The pound has had a terrible year against a mighty dollar:

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More broadly, just having a terrible year. Here is the Bank of England’s trade-weighted sterling index, which shows that the currency is down approx. 6.5 percent against a basket of other currencies:

© Bloomberg

Against the euro, it looks bad, but not completely terrible:

© Bloomberg

For some people, that may be sufficient insurance, but given the dominance of the dollar in the global financial system, having cable near four-decade lows is not good.

The biggest concern, however, is how hard it is to see things getting better from here.

Today’s drop has followed sales figures for junk shops. The number of goods sold across the UK fell 1.6 per cent in August, according to the Office for National Statistics, against expectations for a 0.5 per cent fall. It’s bad.

Unfortunately, it appears that the decline can be partly attributed to the summer holiday comeback. Here’s Barclays’ Investment Sciences team, led by Ben McSkelly, in a note published today:

We believe there are some plausible theories as to why spending is declining.

1) Overseas summer holidays have picked up again so spending on other services has reduced because consumers are not physically in the UK to spend in sterling.

2) Consumers have cut back to pay for holidays abroad.

3) Consumers are generally cutting expenses in response to the increased cost of living.

You can’t really blame people for going on vacation given the whole pandemic that’s been going on lately. But from sterling’s perspective, that’s about the worst they can do.

In theory, Sterling’s defender should probably be the BoE, which insists it does not target the exchange rate. Hawkish external monetary policy committee member Catherine Mann has previously argued for rapid rate rises to try to support sterling, saying that by doing so the weak currency’s effect on import prices could be alleviated.

George Saravelos of Deutsche Bank – which is in something of a nerdy beef with Barclays over how screwed up sterling is – says the bank “needs to step up”:

We showed last week that the GBP in particular is vulnerable to serious balance of payments funding problems. Of course, this will not manifest itself in the same way as in 1992 or 1976, as there is no currency peg to break. But it means that the exchange rate is vulnerable to extreme dislocation if the Bank of England does not step up its response. A record current account deficit and more than 5% of GDP financial expansion financed with a real interest rate of -1% is simply not sustainable.

But Threadneedle Street is taking the heat from several angles: even as its major peers (Federal Reserve and European Central Bank) went for 75 basis point hikes, the BoE faces the double shock of having to adapt to changing UK fiscal policy, and a rapidly darkening economic picture.

Here is the Barclays finance team:

We expect the bank to increase 50bp at the meeting in September and approve the start of the QT programme, subject to market conditions. But the government’s energy package and increasingly unfavorable economic data appear to be forcing the bank to reset the narrative towards a more gradual tightening, probably in November.

Ugly data like this morning’s – and the likely GDP hit Britain’s State of Obligatory Sadness deal – tie the BoE’s hands further (the old lady has also done little to show her conviction by postponing a rate hike due yesterday until next week, based on an inexplicable notion that doing so somehow honors the Queen’s memory).

And, as Rabobank’s Jane Foley notes, it may be too late for blowout trips:

The promise of higher interest rates is no guarantee of GBP strength when the economy faces recession.

There’s a pretty compelling case that the only way is down.

The markets seem to be preparing for such an eventuality. After a period of recovery, net positioning on GBP/USD has taken another bearish turn:

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Interestingly, this reflects a schism between asset managers and leveraged funds: check out the chart below, of the spread between the positioning of the two groups. That’s the widest since 2006. Hedge funds, which are about the longest pound in four years, face getting burned.

© Bloomberg

Looking more closely at positioning, there is a large build-up of fairly bearish positions for December – traders don’t seem to be betting on parity this year, but record lows are now often bet on:

© Bloomberg

All this bodes rather poorly for the pound. As SocGen’s Kit Juckes put it in a note last week:

There is a good chance that King Charles III will become the first British monarch to pay more than a pound to a dollar, or more than a pound to a euro, or both.

I hope everyone enjoyed their summer holidays – maybe Turkey next year?

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