Pound Sterling Slides into Weekend

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The Pound went from hero to zero on Friday as government actions on both sides of the Atlantic served to undermine fragile investor confidence, sending stock markets and risk currencies tumbling ahead of the weekend. 

Financial markets were a sea of red and so too were Pound Sterling exchange rates, with only the oil-exposed GBP/CAD and GBP/NOK able to cling to fractional intraday gains while European and U.S. stock markets swapped earlier increases for steep losses as the mood among investors soured. 

This is exactly the kind of environment that has recently elicited vaccine-related statements from pharmaceutical companies and certain U.S. politicians, which have so-far had the effect of patching up sentiment and stabilising asset prices.

Sterling had performed well against all major currencies until mid-day when the rug came out from under it, although assigning blame for the Pound’s plight is complicated by the fact there are two candidates for responsibility, with the only one common theme between the two being the hands of government. Still however, it did cling to weekly gains over some currencies

“The increase in coronavirus cases in Europe has not been accompanied by a sharp rise in deaths. As a result, most governments have not yet reintroduced national lockdowns, although there are suggestions that the UK is considering re-imposing one,” says Simona Gambarini at Capital Economics.  

Source: Pound Sterling Live. 

“Our forecast that equity prices will make renewed headway in the next year or so is predicated on fresh outbreaks of COVID-19 remaining fairly localised. That assumption is being challenged by a resurgence in coronavirus cases in Europe. Even so, we suspect that the pull-back in global equities over the past couple of days will be short-lived unless the rise in new cases starts to weigh more heavily on the economy again,” Gambarini adds.

The Pound has had a strong correlation with stock markets, especially the U.S. S&P 500 index, and most equity benchmarks tumbled on Friday although Sterling’s losses were already building before the S&P 500 tanked. 

Sterling came under steadily increasing pressure after the government imposed tighter restrictions on freedoms in more parts of the North of England in response to a second wave of positive coronavirus tests that have stoked an almost hysterical response from government ministers and their advisers. 

New 'cases' rose from 829 on July 01 to 3,991 for September 16, according to the government, but in that time the seven-day average number of deaths fell from 37.3 to 11.85 and total deaths reported for September 16 were just 6.

More than a month after new daily 'cases' rose back above 1,000, the death rate had fallen below 0.1% and was still declining despite fatalities often exceeding 15% of new infections disclosed during the first wave.

Restrictions came amid speculation of a possible second ‘lockdown’ and ahead of a claim from Prime Minister Boris Johnson suggesting he doesn’t want another national shutdown, although he also warned one could still be likely.

 Above: Pound-to-Dollar rate shown at daily intervals alongside S&P 500 index futures (orange line, left axis). 

“The atmosphere across stock markets is turning sour as the weekend looms, as investors fret about possible retaliatory measures from China after the US announced a ban on key apps from Sunday. Such a move opens an entirely new dimension to the US-China standoff, and puts major tech firms squarely in Beijing’s sights,” says Chris Beauchamp, chief market analyst at IG. “As the week comes to a close it looks like more pre-election losses are in store. The Nasdaq continues to lead the losses for US markets, which is a very negative sign for equities in the near-term; such an absence of risk appetite flags the potential for a much bigger drawdown as the election nears.” 

Stock market losses really began to build after the U.S. Commerce Department said that distribution and/or maintenance of WeChat and TikTok applications will be banned in accordance with an August 06 order from President Donald Trump. Provision of other services to or from either will also be banned.

Confirmation came around mid-day and lifted USD/CNH to a second consecutive day of gains as the six-week rally in the Chinese currency faltered further. Bans are intended to force each company’s U.S. operations out of Chinese hands, or out of the country “to protect the national security.” 

This may have had more of an impact on Sterling than many might commonly appreciate given that it's now thought to have one of the strongest correlations with the Chinese Yuan and other emerging market units among major currencies. Some have even gone so far as to suggest that it might actually be becoming an emerging market currency. 

“The stand-out exception to its historical sensitivity is GBP, where the recent beta is almost as high as commodity currencies," says Adarsh Sinha a strategist at BofA Global Research. "This likely has less to do with China exposure and more with the generally higher beta nature of GBP in recent years. As our UK team has highlighted, there are many ways in which GBP trades more like an emerging market than G10 - this is yet another example!”

Above: Pound-to-Dollar rate shown at daily intervals alongside CNH/USD (orange line, left axis). 

The Yuan has rallied since late July, putting pressure on the Dollar and lifting emerging markets. It’s not clear what triggered the move but USD/CNH reached its lowest since May 2019 and the last escalation of the trade war this week, after being aided by better-than-expected economic numbers. 

However, the Chinese currency’s gains have left it and potentially Sterling vulnerable ahead of the November 03 U.S. election. Bans on Chinese social media firms demonstrate that mistrust and hostility still bubble away beneath the surface in Washington at least, and could foretell what’s to come in the event of a surprise election win by President Donald Trump on November 03. 

The rally has so-far erased one half of the U.S. trade tariffs from history but those levies still remain in place on Chinese goods while Trump has hinted numerous times of a desire for a complete “decoupling” from the world’s second largest economy. There might be little left to persuade him against that course of action in any second term given the incumbent will then be a 'lame duck' President who's unable to occupy the White House for a third time.  

All of this comes alongside a deteriorating relationship with the European Union, diminished prospects of a free trade agreement and under a heightened threat of something like a ‘no deal’ Brexit playing out after year-end. Both sides have clashed over the controversial internal market bill, which is a response to equally controversial implications of the EU withdrawal agreement and what government says is a “bad faith” approach from Brussels in the trade negotiations. 

“There are hopes among some that, even if the 50 rebels needed to defeat the bill (assuming that Johnson will have the full support of the DUP) can’t be found, an amendment can be passed that severely constrains the government’s ability to actually put the law into practice, for example by requiring parliamentary approval before any controversial steps are taken. Some also still hope that the introduction of the bill represents nothing more than a negotiating strategy designed to pressure the EU, hoping that it could actually catalyse the near-term breakthrough in talks needed to make it immediately redundant. Johnson has shown “heroic flexibility” in the past and is likely capable of changing course easily without loss of face,” says Shahab Jalinoos at Credit Suisse. “Still, we are not inclined at this stage to fade GBP weakness on hope alone.”

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