Tuesday, 11 October 2016

Oh me of little faith.

Whilst the bickering in US politics continues, I wish to avoid comment and instead go back to the once mighty pound, though I do note that the Trump hedge has just become cheaper.

I will put my hands up to being flabbergasted by the Tory party statements last week. The ones that flabbergasted the rest of the world with their implications of returning to the UK being run along the lines of old golf clubs. May and Rudd’s speeches catapulted international expectation of the UK’s Brexit outcome to one of isolationist arrogance.

Now, one of two things can happen. Well actually one of many things can happen but let’s stick to two. The UK government can learn from the global reaction and bend to a more conciliatory line or they can carry on the path to the 1950s, complete with the dream of a new UK car industry producing 1950’s quality cars (I'll have an Austin Healey please), coal mines, Blackpool holidays and, why not, even bring back Pounds, Shillings and Pence.

I am praying that the feedback of international reaction, via the diplomatic service, bends policy and some of the more draconian members of Cabinet are let go. Liam Fox may be a great chap to go for a beer with, but his understanding of diplomatic nuance is somewhat truncated and from what I gather the civil service has, allegedly, already written him out of process. But when I talk about international reaction I am looking mostly at the US. The EU have made it blatantly apparent that they are playing hardball and the tone of any pre-official dialogue is as intransigent as that expressed by the likes of M Hollande. My concern after last week’s speeches was the shocked reception it met with in Washington. May and Rudd need to adapt.

One of the benefits to the UK is that it makes our exports more competitive. But one has to take care as I am wondering if a large part of the export boost we are seeing is the rest of the World effectively clearing out our inventory. Inventory that has seen its input prices priced at £/$ 1.50 but output sold at £/$ 1.25. there is going to be a sweet spot to buy up everything that has an external price function in it before the FX moves feed through to repricing. So, as UK consumers should be buying up German car parts, Bosch dishwashers, Miele vacuums and Stihl hedge trimmers before they all go up in price, so should overseas companies be clearing out all of our manufactured goods that are currently sitting in inventory. The problem comes when the FX moves feed through and the prices go up. At that point there is a strong chance that the export boom we are currently seeing subsides.

The effect is fastest with goods heavily dependent upon materials and lagged in anything that is labour intensive as wage pressures are normally last in the inflationary line. So services will benefit longer than manufacturing. Creatives in Hoxton, Ad execs in Soho, accountants at London Bridge and lawyers in Holborn are going to be competitive longer than a JCB digger that is reliant on importing 65% of its parts.

With most banks now calling for cable to 1.10 (It was 1.20 until they were forced to extend the pencil line as time over took them) I wonder what it will take to get anyone to buy pounds back. Traditional measures have it undervalued  but markets are forward looking and the departure from the EU is not appearing in  current traditional measures though it is being discounted in the price. My own long term belief is that GBP/USD trades at 1.6000 which is probably a classic example of price anchoring as that is what it has averaged since I started out in the City a very long time ago. 1.60 has been to cable what 1.10 currently is to EUR/USD.

I am certainly not calling for cable to hit 1.60 by year end, especially with the USD so strong on the belief of clever people that stupid people will no longer vote for Trump (dangerous thought process), but with ‘this time it is different’ echoing around and the pendulum of UK government expectation swung solidly to ‘hard brexit’ I feel there is finally room for any change in news to be less negative for GBP. Add to that the massive positioning of shorts in GBP futures markets and I have started to buy it again after any brief losing venture in cable from 1.28 to 1.25. I also note that Gilts actually went up today, but then so did most global bonds.

On to other things - Oil is still going up, this time apparently thanks to Putin suggesting he is willing to participate in slowing production, though my oil friends tell me that due to technical things involving ice in the oil up there it isn’t an easy process. But my worry with Putin goes further than that and I'm very surprised that there is so little concern expressed in the markets at the continued deterioration of relationships between Russia and the West. Why is this? Because the current market participants are too young to remember the abject fear we ll lived during the cold war? Or just that the only real trade to hedge for complete West / Russia war is nuclear bunkers, iodine, guns and gold and to mention that in a serious investment forum would see you despatched pronto.

Is there an ETF that markets itself as a war hedge? Would be quite a thing to develop as you could be pretty sure that if the worst came to the worst your claimants would probably not make it to knocking on your door. Perhaps it could have a trade code ZH1

My Positions.

Long GBPUSD (again)
Short EURGBP (fresh)
Short BTPs (forever)
Long Oil. (though now seeing potential for a pullback)

Signing off - 'Long Pound Pol'

1 comment:

cantdeletemyf-ingaccount said...

I agree with basically everything you said, and all of this was my thesis for being long way back when we were at $1.30 (a very painful trade, that one). The economy is at full employment, yet the trade weighted GBP is close to an all time low. And no matter what the rhetoric on Brexit right now is, I don't believe either side will want an outcome that inflicts serious damage on the UK economy - cool heads will prevail and some sort of compromise will be reached. So for me, the fundamentals do not justify where we are now by any stretch of the imagination, and I think the economy will continue to outperform expectations over the next few quarters.

My concerns, and the reasons I'm holding back for now, are twofold. First, that 'flash crash', but more importantly the failure to recover from it (and actually the follow through we've had the past three sessions), suggested something much bigger is going on here and that growth fundamentals just won't matter for the time being. Even if I think the market has it wrong on Brexit and is taking the political rhetoric too literally, the weight behind this is just too great. Second, the extreme volatility in GBP right now does not lend itself to funding that eye-watering current account deficit. Overseas investors will only keep investing in the UK if they believe the currency is going to be reasonably stable. Can the pound be considered reasonably stable anymore? For a country with a surplus or even a small deficit, this wouldn't be an issue, but the UK is uniquely vulnerable in this regard. This could get even uglier in my view.

So, I'm on the sidelines for now. I would probably get back in if we get to ludicrously cheap levels (sub-$1.15) or if we start to see a meaningful shift in rhetoric over Brexit.