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Pound Vulnerable Against Dollar but Sterling-Euro Could Stabilise

  • GBP/USD at new 2021 lows & GBP/EUR below 1.18
  • After new virus strain prompts global market panic
  • Uncertainty pervades with little known about strain
  • GBP/EUR downside limited but GBP/USD vulnerable

Covid variant drives losses in the Pound

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Pound Sterling suffered heavy losses against low-yielding funding currencies and perceived safe-havens ahead of the weekend after a new strain of the coronavirus prompted a global market panic, which could have differing implications for GBP/EUR and GBP/USD going forward.

Sterling sustained its steepest losses against the safe-haven Swiss Franc on Friday but was also deep in the red against the Japanese Yen and Euro while seeing more modest declines against the U.S. Dollar as investors responded to the discovery of a new coronavirus strain in Africa.

The Pound to Euro exchange rate fell almost a full percent owing to both a modest decline against the Dollar and a rally in the Euro-Dollar exchange rate, which alongside GBP/USD is one of two primary drivers of GBP/EUR.

“The EUR rally probably speaks to an unwind of recently built carry positions. That said, we think liquidity (and lack thereof) has been a significant driver behind the move,” TD Securities noted ahead of the weekend.

GBP quotes

Above: Selected Sterling exchange rate quotes and performances over various horizons. Source: Netdania Markets.

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The Euro, Yen and Swiss Franc had been sold heavily throughout the year by investors and traders who used proceeds from those sales to fund wagers on more appealing and higher yielding currencies such as Sterling, the Dollar and the commodity currencies like the Canadian and Australian Dollars.

These were evidently some of the first positions to be pared back on Friday as the first details of the new virus strain first discovered in South Africa reached investors and traders.

“This is the product of a position wipeout in USDJPY (and EURUSD) and is interesting given we saw nothing like this in July on the delta variant. This shows you how aggressively the market piled into USD longs after Powell was nominated,” says Brent Donnelly, president at Spectra Markets.

The global market response on Friday was significant, with stock markets falling heavily across the board while some commodities such as oil fell by double-digit percentages in what could yet turn out to have been an overreaction.

Global market quotes

Above: Selected market quotes and performances over various horizons. Source: Netdania Markets.

But other than that the new virus strain contains a number of mutations compared to other variants, very little is actually known about it so far.

Some market observers have expressed concerns that it could turn out to be more transmissible than others or resistant to available vaccines, with the idea being that it could give some governments a reason for attempting to reimpose restrictions on business activity and social contact.

This is one reason why downside risks for the Pound-to-Euro exchange rate could be quite limited and less than the risk of further losses for GBP/USD.

“The lesson from the past couple of years is that it’s the restrictions that are imposed in response to the virus – rather than the virus itself – that causes the bulk of the economic damage. So, the key question is how governments will respond in the event that the B.1.1.529 strain spreads,” says Neil Shearing, group chief economist at Capital Economics.

exchange rates

Above: Pound-Dollar rate shown at daily intervals alongside Pound-Euro rate.

“Different approaches to managing the virus are starting to emerge. In the UK and the US, governments have shifted a bit more towards an approach of “learning to live with the virus”. This means the bar for imposing severe restrictions on activity is probably higher than in Europe, where governments are already adopting new measures in response to a spike in the Delta variant,” Shearing wrote in a note to clients on Friday.

There are almost no virus-related restrictions in effect in the UK, which has one of the highest vaccination rates out there, although in Europe some governments had already resorted to reimposing ‘lockdown’ and other new draconian restrictions even before the new strain was detected.

Countries including Czech Slovakia, Portugal, Austria and the Netherlands had already shuttered their economies before Friday and fears were that others would soon follow suit, and the detection of the new strain is hardly likely to lessen this risk.

That’s one reason why Friday’s rally in the Euro-Dollar rate may be unsustainable while the Pound-to-Euro rate would likely benefit from any unwinding of the move as it always closely reflects the relative performance of GBP/USD and EUR/USD.

“We doubt the UK will enter lockdowns again, but we had been arguing that it was odd GBP wasn’t already weaker in view of the move in 5yr real yield spreads before the variant’s discovery. We prefer short GBP/USD as a better expression of the GBP view,” says Jordan Rochester, a strategist at Nomura.