The REAL Reason the British Pound is Falling vs the Euro and Dollar

high street british pound 1

  • Pound to Euro Rate Today (11-1-16): 1.1522, day's high: 1.1553, day's low: 1.1502
  • Pound to Dollar Rate Today: 1.2165, day's high: 1.2199, day's low: 1.2148

Pound Sterling has fallen notably through the course of January as markets start to focus on upcoming Brexit negotiations and price in the negatives associated with the United Kingdom's withdrawal from the European Union's single market.

Or at least that is the conensus view.

A drop in inbound capital from investors buying into the bond market may be the significant factor in Pound sterling’s recent decline, according to Société Générale’s Kit Juckes.

in a note seen by Pound Sterling Live, Juckes argues that the Pound is reacting to moves in ‘real’ yields on UK sovereign debt.

The real yield is a bond's yield minus inflation.

So, for example, if a bond has a yield of 3.0%, which means it pays the bond holder 3.0% interest per annum, and the inflation in a country or origin is 2.0% then the real yield is only 1.0%.

This is because in reality the bondholder is actually only making a profit of 1.0% taking into account inflation erosion.

According to Juckes, investors don’t just seek higher yields but actually seek higher real yields.

Juckes posits a relationship between British real yields which are narrowing and the Euro to Pound exchange rate which is strengthening (i.e Pound weakening against the Euro).

EURGBPJan10socUK

UK real yields are also at the bottom of the G10 league table, making UK bonds the least attractive investment in the developed asset universe.

Real yields are narrowing because inflation is creeping higher due to the weak Pound raising the cost of imports.

This, and the fact the UK imports more than it exports – is raising prices.

Yet the narrowing yield/inflation spread may further pressure the British Pound, which will in turn narrow real yields further, in a vicious cycle, causing a negative  feedback loop which will speed up Sterling’s decline.

Thus we have a perfect example of what George Soros called ‘reflexivity’ and made the cornerstone of his investment philosophy.

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Latest Pound/Euro Exchange Rates

United-Kingdom European-sUnion
Live:

1.1609▼ -0.29%

12 Month Best:

1.3286

*Your Bank's Retail Rate

 

1.1214 - 1.1261

**Independent Specialist

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

The US Dollar Could be Too Rich

It's not just the Pound that is throwing up interesting correlations with real yields.

Using a chart comparing the real yield of the 10-year US Treasury Bond with the Dollar index, Juckes shows how there is a strong correlation between the two, and that falling real yields in the US are likely to forebode a weaker Dollar.

EURGBPJan10socUS

Most analysts we have come across are anticipating a stronger US Dollar in 2017, but many are arguing that a period of depreciation must be accounted for.

If the above observations have any predictive powers then such a slip is indeed likely and only when real yields start rising again will the Dollar find upside traction.

 

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