Having fallen off a cliff on the day the results of the UK referendum to leave the EU came through, the British pound rallied at the start of September as August PMIs revealed better-than-expected results after their July slump.
Sterling touched $1.33 against the dollar on manufacturing PMIs. That compared with 24 June, when the pound fell more than 10 per cent against the dollar, reaching $1.32 from $1.49 on referendum day. It hit a low of $1.28 in the first week of July.
But as Bank of England governor Mark Carney stated when questioned by the Treasury Committee, early economic indicators are a “few straws in the wind” and are being buoyed by the consumer sector, while big investment decisions are being held off.
According to data compiled by Bloomberg, currency forecasts for the next three months suggest the pound will be around $1.27, and will more or less settle there over the following nine months. Economists from UBS and Allianz, however, suggest parity with the dollar is plausible if the UK does not develop a comprehensive Brexit plan.
FX and fixed income portfolio manager at Neuberger Berman Ugo Lancioni says the recent rally has not been “massive” and that short positioning on sterling assets will not see an immediate switch.
“Implied volatility in the sterling market has collapsed so it seems the market is not pricing in any dramatic scenario in the coming months.” This is because the triggering of Article 50 and negotiating the exit from the EU has not happened yet,he says.
The Neuberger fund manager questions whether the depreciation of sterling is excessive relative to the expected impact of Brexit.
He says: “From an investor perspective my view is that sterling has discounted too much on the negative Brexit impact and the short position represents a risk.”
The firm had a “positive positioning” on sterling the day of the Brexit vote, which “didn’t help”.
“However, we kept that position after the drop and we added to it slightly so the most recent move up has been working in our favour. We tried to be as neutral as possible. But that doesn’t mean I am positive on the UK economy. Over the long run Brexit is going to be negative for the UK economy.”
Lancioni says the future impact on currency “will be limited” until Brexit takes place.
But others take a different view. According to Justin Oliver, deputy CIO from Canaccord
Genuity Wealth Management, the pound is more shorted than it has ever been.
Short positions of around 94,000 contracts compares with a long and positive position of 56,000 in June when investors were positioned for sterling to rise, according to data by the Commodity Futures Trading Commission.
Sterling will see “continued erosion”, says Oliver, arguing it is “under pressure” from the lack of clarity around Brexit.
He says: “We have been underweight sterling assets since before the vote so that has been beneficial for us. The path of sterling will gradually be undermined as weaker data will come through and determine whether we’ll have a ‘soft’ or ‘hard’ Brexit.
“Sentiment toward sterling is at a low ebb and while such a position is often an opportune time to maintain a contrarian stance, it is hard to see sentiment shifting suddenly in this case.”
Contrarians do exist, however. Rathbones head of multi asset David Coombs says sterling is undervalued – although he has not changed the exposure in his fund after the recent rebound.
“Currency will continue to be volatile and weaken in the short term,” Coombs says.
“However, we still have a lot of exposure in our funds and we think it is still good to have a currency exposure in multi-asset funds as overseas investors will focus on Brexit after the negotiation.”
AJ Bell investment director Russ Mould says if the sterling maintains its recovery, the worst- hit sectors, such as those consumer-focused, which underperformed after 24 June will reverse their trend.
He cites the FTSE 250 for a possible mid-cap rebound and the FTSE All Share, which has many general retailers names as having the potential to benefit from a stronger pound.
For this reason, funds with retailers names in their top 10 holdings, such as the JOHCM UK Dynamic fund, should also benefit from a sterling rebound.
Regarding the UK’s relationship with the European Union, Paul Lambert, head of currency at Insight Investment, a BNY Mellon company, says the outlook for the pound is not good.
He says: “Anything different to what exists now in terms of free trade agreements would be negative so currency will react to that.”
Lambert argues depreciation has not been “excessive” with regards to the impact of the vote, but rather has been “relatively modest”. He says: “If we do have Brexit, the pound will fall further and that is why we are short.”
Lambert says more discounting will happen at the time information becomes known “but we don’t know to what extent”.
He says: “The outlook for sterling is complicated because of timeframes. The Brexit vote has happened but that triggered a process and there are still a lot of things we don’t know about
The benefits of a weaker pound and the loosening of monetary policy by the Bank of England will start to fade and the exit of the EU will be the new focus, argues Lambert.
“The challenge for us is the positioning: we recognise the market has a short pound position, but in the absence of momentum, that position gets squeezed. We won’t be adverse and go neutral but we’re still short and taking advantage of the volatility although prices are falling a lot.”
However, it is difficult to find any attraction in alternative currencies right now, according to Oliver, who warns on any short-term currency switching decisions.
He says: “The euro has challenges as well. You don’t want to buy Japanese yen as more stimulus from the Bank of Japan is underway. You need to be careful if you are switching and get out of sterling – as in where you are going next. You need to make sure you have a good conviction call if you do that.”
Emerging markets currencies are the potential bright spot Oliver points to, saying he has added to the India rupee, despite nervousness at the current mass reswitching to the region by many of his peers.
The next move by the US Federal Reserve is crucial for UK currency, according to TwentyFour AM fund manager Chris Bowie.
“The next few months are key because of what happens to US interest rates, as interest rate differentials will drive the currency pair,” says Bowie, explaining he expects a December rate rise in the US.
“If that happens, and the Bank of England possibly cuts rates further, I’d expect a stron-ger dollar versus the pound. However, if the UK economy continues to surprise on the upside, as it has done recently, it is certainly possible that the pound could recover to $1.35 or better.”
Lancioni says the destiny of sterling and the rates market is going to be about inflation and economic data.
He says: “Data is going to be more meaningful as we get more information about how businesses are thinking about the upcoming Brexit. Still, until you get negotiations, those businesses won’t have strong views.”
Whatever the case, Mould stresses a word of caution. He says: “Picking currencies at the moment is a dangerous game. The FX market is incredibly difficult to second guess so your
allocation to currency is a brave thing to do so it shouldn’t be a major factor to consider. However, the dollar remains the key currency, like a year ago.”