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Nervous bullish case for the pound sterling

By Matein Khalid

My tactical idea last week to recommend buying sterling against the US dollar (cable) at 1.30 for a 1.34 target is 200 pips in the money now that the Bank of England kept the policy rate unchanged at 0.75% despite Governor Carney’s smoke signals. Sterling closed at 1.32 on Friday evening and will be well bid next week – hopefully.

I expect Governor Bailey will keep the base rate unchanged at the next two Monetary Policy Committee conclaves since the Old Lady of Threadneedle Street expects a significantly increase in public/infrastructure spending in Chancellor Javid’s March Budget. While the BOE dissed the Tory government with a much lower GDP growth forecast, the fact remains that there was a rise in manufacturing PMI, house prices, business/consumer confidence and portfolio inflows since the Tory landslide win over Labour/Corbyn in the December 12 UK general election. I have been a consistent sterling bull ever since mid-September at 1.20 on this media platform once no deal Brexit was priced out of the foreign exchange market and data momentum pointed to no distress (other than retail) on the High Street.

Speculative positioning on the Chicago Merc’s IMM British pound futures data and the risk reversal skews in the sterling FX option market also tell me that the British pound is under accumulation by the smart money, the cognoscenti of Planet Forex and the gnomes of Dubai! The successful Brexit alone removes a source of protracted political risk on UK assets, the reason I have been bullish on Barclays – God Save Our Gracious Jes! I expect British gilts are a classic short now as the yield on the ten year UK Treasury note could well rise to 1.20% even as sterling rises to 1.34 on cable and 81 – 82 pence on the Euro.

With West Texas crude down 18% from its most recent post General Soleimani peak, the CRB commodities index a disaster and the coronavirus risk aversion/volatility spasms on Wall Street, I believe the Canadian dollar will depreciate against a rising sterling in February. So another money making idea would be to go long quid/short loonie in the elegant Queen’s English spoken by my FX punter’s tribe, duckies! The Aussie dollar dropped 4% against the greenback in January due to the brushfires tragedy and China woes, but I expect the RBA in Canberra will be vigilant about imported inflation in Australia and thus resist an interest rate cut that might be more likely in Ottawa.

A fiscal stimulus and tight monetary policy is invariably bullish for a world hard currency. This is the policy mix that led to King Dollar under the President Reagan/Volcker Fed regime in the early 1980’s and the Chancellor Kohl/ Tietmeyer Bundesbank regime in Germany after the fall of Berlin Wall in the early 1990’s when it was really Deutschemark Uber Alles in the EMU, as the world found out the hard way when sterling was forced to exit from the EMU on Black Wednesday, 15 September 1992, the day George Soros and Stan Druckenmiller skimmed a billion dollar profit to break the Bank of England.

Even Trump White House’s tax cuts and the Powell Fed’s monetary tightening can explain the King Dollar trend that so upset the Twitterer-in-Chief in 2017-18. Yet Britain could well replicate this fiscal stimulus/tight money policy mix in 2020 and thus ignite a serious rally in the pound sterling upto 1.40 – hopefully, from my perspective. In the FX business, hope can get me skinned alive but I definitely see the balance of risks tilted towards a higher sterling in the next three months even as the Powel Fed does its best to expand, not contract, its balance sheet as the de facto lender of the last resort to the world amid a global epidemic outbreak that has just devastated the planet’s second largest economic superpower, a $14 billion GDP colossus known as the Middle Kingdom.

President Xi Jinping consolidated more power in the Politburo/State Council to become the most powerful Chinese autocrat since Mao and Deng but he now faces do or die crises on multiple fronts – Hong Kong, Taiwan, the Wuhan coronavirus, a 350% debt/GDP ratio, corporate defaults, public rage, awful demographics, ethnic unrest in Sinkiang/Tibet and a technology/trade Cold War with the Trump White House. The endgame? The Chines yuan will depreciate well beyond 7 to 7.30 by this summer. In foreign exchange, we prefer to pair the strong with the weak so it may also be profitable to buy the British pound against the Chinese yuan now.

I track Chicago Fed Fund futures markets to get a grasp on the US monetary policy colossus. The effective Fed Funds rate in the money markets is 1.5% but the futures markets implies one definite FOMC 25 basis point rate cut and possibly even two Fed rate cuts after the twin coronavirus/Chicago PMI shocks. If Trump announces a payroll tax cut at his State of the Union address and Bernie Sanders beats Joe Biden in the Iowa primary, I expect the US dollar to sag against sterling next week. This is the strategic rationale for my 1.30 long cable call idea for a 1.34 target posted last week as gift to my followers and readers. So hope you all are cruising gently in the Bentley, lads and ladettes. In life as in the financial markets, I never loose the opportunity to increase the continually expanding frontiers of my own ignorance.

I expect the Euro to depreciate against the sterling in the next two months, possibly to as low as 82 pence due to a policy mix of fiscal stimulus in Berlin, but also ECB easy money in Frankfurt and economic contraction in France and Italy. The CDU wants tax cuts, the SDU wants infrastructure spending and Chancellor Markel wants a legacy of “mehr (more) Europe” even while the gilet jaunes are busy reconstructing Madame Guillotine on the Place de la Concorde (should be renamed Place de la Tristesse after what happened here in the time of the Terror). The Jupiterian Presidency in the Élysée Palace is now literally under siege and this is never positive for the Euro, unless the French paras promise us the Sixth Republic LOL!

Net net, the macro omens argue for a weaker Euro against the sterling in the years ahead. With core CPI at a mere 1.1% in the eurozone, Madame Lagarde dare not even think about a tightening of the negative discount ECB policy rate. A bearish strategy call on Euro/sterling thus seems screamingly logical to me. As the global auto industry enters its terminal death rattle and the Russian Empire exhibit its periodic succession crisis geopolitical convulsion, I expect Britain will outperform the EU by a significant margin. Who owns Land Rover, Jaguar and now Aston Martin after all? The prospect of a US trade deal with Westminster is also another sterling positive theme for 2020, as is the significant global underweight in cheap, unloved British equities and risk assets.

Also published on Medium.