Let's try a classroom activity - we are looking at GBP:
Who's still short at this point? Raise your hands. Mhmmm.
Who's long? Not many. Huh. That's what I thought.
The myriad of reasons that has pulverized GBPUSD has been well telegraphed (divergence in central bank policy, Brexit, etc). I get it. But this reminds me a little of EUR in 2012/2013 when the world was convinced EUR was headed lower, and everybody who jumped in short at what eventually turned out to be the bottom had their faces ripped off.
I'm not necessarily recommending a direct GBPUSD long, but you damn sure don't want to be short here.
A couple quick things to mull over:
- At these levels, Cable is showing historically low levels when it comes to value using CPI and PPI based real effective exchange rates. This means that GBP has become much more competitive and valuation is stretched to the downside.
- Good Brexit vs Bad Brexit. Obviously, we've heard of all the terrible ramifications of Brexit - but has anybody ever considered the positives? I'm no expert at deciphering British politics but let's think about this: capital goes where it is treated best. There is no shortage of EU regulation forced on the UK in the past (costed UK billions). UK was a big contributor of EU taxes - that money comes back.
Donald Trum...Err, I mean Nigel Farage? Check.
Wait, so how is this not boom town and we are not off to the races?
Ah! But we have been...
- UK breakeven inflation has ripped. CPI has ripped. CPI including housing (the one that Hammond wants to switch to) is already at 2% - the inflation target for the BOE
- Citi Economic surprise index is persisting at very strong levels for the UK. Growth rates are being revised up and unemployment is at levels last seen in 2005. Industrial production YoY broke out of its slumber at end of 2016.
- On top of all of that, the Fed is ripping rates higher and the BOE is....
Really? Seems either mispriced or Carney is falling behind the curve as the cable guy. Brexit uncertainty shmertainty. Doesn't scare me. I know what my eyes see.
- So what now? Well, like I said, you might want to head for the exits if you're short Cable (but hopefully 2016 was great for you!). There is a lot of dollar risk if the Fed fail to disappoint in the upcoming 9 months, so if I was to go long, check out GBPJPY or GBPCAD.
- You can look for opportunity in rates as well. Short Sterling greens look a bit rich and could probably be a fade on rallies. If the BOE falls behind on inflation, 19s to 20s short sterling must steepen enormously. So 19s, or 19s to 20s, or 20s short sterling curve steepeners might work here as well.
Have a good weekend guys. See you next week.
Macro Clown (MC)