Image © Adobe Images
Selling the pound for political reasons could be risky says a seasoned FX trader.
Alan Stewart, Head of EMEA EM & G10 FX Spot Trading at Goldman Sachs, says it's futile to sell the pound on political narratives, and that traders are best served looking at the economic and interest rate trajectory.
The call was made on the eve of the Makerfield by-election, which Andy Burnham comfortably won.
Stewart's instincts were right: the pound is actually higher on the morning that the results are being absorbed by the British public; the pound-to-euro rate (GBP/EUR) trades higher at 1.1534. We're watching GBP/EUR here as it's the better indicator of UK-specific sentiment, given the overwhelming influence played by the USD in the GBP/USD pair.
"With the by-election as well, the market is looking at GBP both as a funder and as a valid short. Ultimately, GBP weakness will be a function of economic underperformance, not political disappointments," says Stewart.
"The market has tried and will continue to try to play GBP shorts on political drivers, which I think is a mistake," he adds.
Above: A difficult week for GBP, but the Makerfield result didn't register as a negative trigger.
The trader still sees pound sterling weakness ahead, but that's going to be a function of economic and interest rate drivers, where the outlook is not constructive.
"GBP is interesting, it could be a little vulnerable. The weaker CPI yesterday should make it easier for the BoE to lean more dovish," explains Stewart. "The weakness probably comes in the second half of final quarter of the year, when the BoE does not hike and the UK’s data materially underperforms."
"So this is more about sequencing," he adds.
The call comes in a difficult week for the pound: falling oil prices owing to the U.S.-Iran deal have lowered inflation expectations and dragged UK bond yields lower as a result.
The pound benefited earlier in the war when yields rose, confirming the pound to be a beneficiary of the UK's yield premium. The vulnerability was always that the premium would rapidly fall once the war ended.
Inflation undershot expectations at 2.8% and the Bank of England showed little inclination to deliver an insurance rate hike at its meeting on Thursday.
For sterling, there were no positives on offer.
"At the margin, in a moderately weaker dollar environment, EURGBP is the better vehicle to express GBP shorts. The broader 0.86-0.88 range should hold, and we are currently toward the lower end of that," says Stewart.
For those watching the pound-euro angle, that range translates to 1.1630-1.1364.