After the Brexit “V” shaped stock market sell-off and recovery, certain algorithmic trading models received sell signals in the British pound. Other models pointed to a potential knee-jerk reaction and a weak signal. Capital Economics, considering a fundamental take on the British pound, looks at what appeared to be a scare campaign and says they are not afraid. In an August 10 report, they recommend buying Sterling and point to it as a potential safe haven against the US dollar and more pointedly the euro.
Primary performance driver in British pound might now be central banks
As the British pound moved below $1.30 on Tuesday, trading just above the post-Brexit low of $1.28 on July 7, a subtle shift in performance drivers appears to be taking place.
Whereas Brexit fear was leading the initial sell-off, the Capital Economics piece now points to “dovish” comments out of the Bank of England pointing to artificial market intervention as a potential drag on Sterling.
“The political risks that contributed to the initial fall in the pound after the Brexit vote have now faded,” Capital Economics Julian Jessop noted.
In the USD/GBP relative value spread, US central bankers may have more influence
Without weighing in much on the potential negative impact of central bank stimulus on the pound Sterling, saying this performance driver might be “largely priced in,” Jessop noted the Fed likely raising rates at least once in 2016 is likely to drive the pound / US dollar currency pair more than British rate hikes.
In fact, the pound could be a beneficiary over the US dollar, “seen as a safe haven from uncertainty in the US ahead of (and perhaps after) the Presidential elections there in November.”
While the dollar end of the pound relative value price might be most influenced by the dollar, so too the pound / euro spread could be most impacted by the euro currency. The British pound could be the “safe haven” play against the potential for “fresh crisis in southern Europe and additional easing by the ECB.”
These performance drivers have two loaded concepts centered in both the US and EU.
Capital Economics says pound could be safe haven from euro, US dollar
While the US presidential elections appear to have widened significantly on self-inflicted wounds of one candidate, anything, including the threat of violence, could ensue. Separate analysis indicates the more significant performance driver could be the US Federal Reserve. If the economy begins to strengthen, and US central planners increasingly have the gumption to raise rates off emergency levels, then interest rates could rise and the US dollar would be expected to positively correlate.
The real market wild card could come from the ECB. The whisper topic is the potential government bailout of Italian banks, initially expected to be near 60 to 80 billion euros, but now the whisper number is close to double that amount. The extent of derivatives involvement in the bailout is unknown. Efforts are expected to be made to obfuscate the involvement of derivatives in the bank losses, if they should occur. It is unclear if the government will make demands on the bailout and claw back bonuses given to derivatives executives who mis-managed their exposure
Capital Economics, for its part, didn’t mention the unmentionable derivatives topic in its analysis. They pointed to potential support against the pound near $1.20 if a sell-off materializes. On the upside, however, they note a short-squeeze could trigger a derivatives led rally if certain triggers are hit.
“Data from futures markets suggest that speculators are already heavily ‘short’ of the pound,” the report said. “Any rally could be accelerated by the closing of these positions.”
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