Moody’s previous downgrading of Britain this year seems like a distant memory now, but the subsequent devaluation of the pound reflected what markets had been pricing in for many years. The smart money has broken its fall from time to time, buying its fate before there is no sense to stay long any longer.
So here we are again, the pound has suffered further steep losses on optimistic yells from our American friends and with the job numbers to back them up too. 195,000 people got jobs in June rather than the consensus for 165,000, which the markets had been prepared for, sending the dollar to the moon. Moreover, with optimism around the subject of the labour markets, tapering is on the cards and a subsequent widening of yields comparatively.
Earlier in the week on Thursday, Mark Carney hadn’t given the pound any favours by telling markets that they were wrong to expect higher rates in the medium term. By medium term, we will just have to wait for the BoE minutes to find out what length of time that might be. But if the ECB’s press conference is anything to make a reference point to within this regard, we know it will be more than 12-18 months as Draghai seemed to indicate when he was answering questions, if not by mistake.
All in all, the pound has started this week much lower and the question now is where does this go next? We have seen lower levels justified before, only to be reversed in a relatively short period of time when short term and positive data releases had surprised to the upside and gave the bulls an excuse to step back in while the market seemed perfectly happy to put the longer term fundamentals aside. The pound moved back from $1.50, through previous highs and towards the higher end of $1.5700.
Nevertheless, this time around, the move lower in the pound comes accompanied with a new forward guidance from a new governor to the BoE, and Carney is unlikely to be worried about a weaker pound. Inflation is all part of the plan. How else can Britain get rid of its massive burden of debt? There is going to be a fine balance required to prevent yields in Gilt’s going through the roof as for fear that QE isn’t cutting it, and simply creating more inflation. If this were to happen, the pound could move a great deal lower and a fall in UK government bonds would be disastrous, and not just for the BoE, for us all, especially UK home owners. After all, its foreign investors money (holders of fixed income UK gilts) that’s keeping the wheels of Great Britain spinning.
Are we on our way to a $1.40 handle?Our little round friend has been trading in a range for around three years, normally topping out at the $1.64 level and bottoming out at a solid support line of $1.53. It has been tested there several times along the way. For some time, the fundamentals haven’t always added up to what our technicals are telling us – but now there seems to be further conviction.
Unless America takes a sudden turn for the worst (possible), or unless Bernanke and other Fed officials indicate that tapering is off the cards, the real question might be whether even $1.40 will hold. The probability is that it will hold for a time; at least looking back over the last 25yrs. Markets, however, like to push barriers, so you might expect to be able to buy on dips into the 1.3800’s.
We then have to consider the fundamentals and how the UK economy had been built upon house prices, finance, and government spending. Crikey, when spokesman from the Old Lady started to talk about negative interest rates as a solution, well before Carney came onto the scene, and whereby the Central Bank will effectively charge banks to not lend their money out, you can begin to see why there are far more attractive places for your money else where and why the pound would need to be much lower to keep anyone interested in Great Britain as a place for short and medium term investments comparing to Emerging Markets and an improving US economy. However, let’s not get too carried away with such speculation and let’s just see what the inflation report and BoE minutes can tell us on the 17th July. Perhaps we can get some of that forward guidance like we have all been promised. The Forward Guidance, mind you, would appear to be Sterling’s fate.