Today’s FX View from IB:
The bigger currency story this morning appears to be the crystallization of a view that after a summer election in Britain, the winning party won’t be strong enough to force through tougher measures needed to reduce the budget deficit. This prospect of a hung parliament in which a political majority is wafer thin, has been a known factor for some time. And while the pound has been ailing against the dollar of late, the drop to a 10-month low against the greenback today smacks of fresh bets against the pound. Elsewhere, the dollar continues to forge ahead against the euro despite a possible German derived solution to the challenge of Greek bond issuance in the weeks and months ahead.
British pound – Not since May 2009 has the pound traded beneath $1.50 against the dollar and since those days of weakness it has subsequently stretched in to the $1.70s. Dealers these days are pouncing on every political opinion poll that moves using them as catalysts for trading the pound. We pretty much already know that beyond an election that will likely happen by May, the government will be weak. The working assumption here is that weakness will make it difficult to implement tough and appropriate measures to tackle the swollen fiscal deficit. The pound reached $1.4781 according to my data here and slipped against the euro to 91.50 pence – a three month low.
A build in fresh open short positions in the futures market according to CFTC data suggests that this is likely a build of fresh bearish sentiment heading in to the election as opposed to investors bailing out of the pound. But a massive purchase by Britain’s Prudential insurance company of the Asia unit of AIG for a $35 billion price tag might have something to do with today’s poor price action also.
But central to the weakness in the pound is the potential that the incumbent government will be frozen in its ability to act when it looks at the sizeable deficit. However, this might be a little short of the mark. Both parties freely admit the scope of the problem and both see a need to reduce. And so everyone in the House of Commons will, or at least should, be pushing in the same direction. The deficit and the state of taxation – corporate or personal – cannot be overlooked on account of a lack of majority. Every member of the parliamentary system has (or should have) an obligation to pay down the level of indebtedness the nation finds itself in. Whether this means higher taxes or lower spending is a moot point. It very likely means both at the same time. Swallow the pill and get to work.
In the meantime, as nasty is the fall in the pound, one can imagine that officials at the Bank of England are pretty happy to see a more competitive environment for U.K. exports. They probably dislike the manner in which the economy arrived at that point. The question obviously for sterling is how much further it will fall. The assault on it could last some time and there is no denying the gravity of the decline. The truth is, however, that the biggest loss in the value of the pound is probably already behind us.
Euro – The euro continues to fall against the dollar and stands at $1.3532 today. Over the weekend lawmakers told reporters that German may well have a plan that will support Greek government bond issuance. That would take much of the pressure off the European bond markets and detract from market drama towards further crisis. The plan would allow for German state-owned lenders to buy as much as €35 billion in Greek bonds. While we know little else surrounding this proposal at this stage, it does seem as though the plan would create two things. First, these banks backed by the German government underwrite the debt if called upon. Second, in so doing it possible reduces the cost of borrowing to the government of Greece. This might soothe bond markets and raise confidence in the recovery. It’s surprising to see the euro lower with the prospect of this deal in the background.
U.S. Dollar – When you stop and think how investors are punishing deficit-ridden nations at present, you realize how the United States is getting off the hook lightly. With the mother of all deficits, sired by Uncle Sam, the U.S. dollar is playing its safe haven ace card every time investors choose to assault any other major currency. Yet that continues to be the case with the greenback 0.7% better to start the week. On Friday investors will learn what the latest jobs data is after last week’s nasty upturn in initial claims. Some reports are already blaming the horrible winter weather for an unusual amount of job losses during this storm season.
Aussie dollar – Despite its physical distance from Greece, the Australian economy continues to feel the weight of the fiscal challenges weighing on the Eurozone. The impact remains one of Aussie dollar avoidance as Greek fiscal situations and its entourage in terms of potential ratings upsets grips traders’ attention. Overnight the Aussie slumped to as low as 88 U.S. cents before moving back to 88.96 in early New York trade. Next week the RBA decides on whether to lift interest rates for a fourth time and is quite likely to move to 4%.
Japanese yen – Rising stock markets helped investor sentiment and took some upwards pressure off the Japanese yen today. Against the dollar the yen is weaker at ¥89.22.
Canadian dollar – The RBA is likely to raise interest rates to 4% overnight and that prospect has helped the Australian dollar continue to rally. The Aussie made a quarter century high against the British pound in part aided by its low deficit picture. A weaker than anticipated reading for China’s PMI survey dampened some sentiment but the Aussie is still up on the day at 89.68 U.S. cents.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.