The GBP/USD is Too Cheap say BNP Paribas, Should be @ 1.64
- Written by: Gary Howes
Analysis from BNP Paribas shows that the US dollar is one of the most overvalued currencies in G10 while separate data shows the British pound is the most oversold. Could these conditions catalyse a recovery in the GBP to USD conversion in February?
The tide is finally turning on the dollar bull run.
The US dollar index has fallen in the last 12 of 14 trading days confirming February to be a poor month to date.
The pound to dollar exchange rate has risen from a multi-month low at 1.4080 to reach the 1.45’s we are seeing now.
Much of the move has come as a result of the USD’s broad-based decline; indeed going forward this will likely be key.
Sending the dollar lower are market expectations that the US Federal Reserve will step back from raising interest rates four times in 2016 with some now even pricing out a rise altogether.
Another factor we must however consider is the issue of the dollar’s overvaluation.
The latest BNP Paribas FEER update notes that the USD is one of the most overvalued G10 currencies.
Only the CHF appears more expensive according to this long-term valuation metric.
On a trade-weighted basis, the USD is trading 20% – or 1.6 standard deviations – above its FEER.
BNP Paribas FEER (fundamental equilibrium exchange rate) is their gauge of the long-term fair value of a currency.
FEER provides an anchor around which an exchange rate typically deviates. Currencies that are misaligned from their FEERs by more than one standard deviation tend to move towards those fair values in subsequent years.
“There are two previous periods when the USD appeared significantly overvalued: in 1986 when the Plaza Accord of co-ordinated intervention weakened the dollar and in 2002 when the US stock market bubble and introduction of the euro prompted the USD’s overvaluation,” says Michael Sneyd at BNP Paribas.
This time, the USD’s overvaluation is largest against the JPY, NOK, SEK and GBP.
“EURUSD appears cheap, trading around one standard deviation below its FEER, while GBPUSD is also cheap, trading 14% below its FEER of 1.64,” says Sneyd.
Latest Pound / US Dollar Exchange Rates
  | Live: 1.3372▼ -0.11%12 Month Best:1.3789 |
*Your Bank's Retail Rate
| 1.2917 - 1.2971 |
**Independent Specialist | 1.3185 - 1.3238 Find out why this is a better rate |
* Bank rates according to latest IMTI data.
** RationalFX dealing desk quotation.
The Pound / Dollar’s Fair-Value has Fallen
If the GBP/USD’s fair value is at 1.64 there is notable potential for a recovery should markets toe the line.
However it must be stated that the previous fair value estimate for GBP/USD was actually at 1.74, the current figure thus represents a sizeable downgrade.
Why?
Sneyd explains:
“The UK’s current account deficit has been increasing since 2011 (Chart 5), reaching 5% of GDP last year. The widening of the deficit is due to net interest and dividend payments declining from zero in 2011 to -£50bn in 2015.
“Originally this decline was widely viewed by economists as a cyclical phenomenon due to the slowdown in the eurozone (a large part of UK foreign income is from a repatriation of profits from eurozone subsidiaries).
“However, after four years we think this decline should be viewed as structural and be incorporated in our FEER estimate.”
The BNP Paribas FEER framework suggests a lower value of GBP is required to offset the decline.
Speculation Against the Pound is Now at Financial Crisis Levels
We also note that sentiment is on sterling has reached extreme levels; there have not been this amount of negative bets placed on the UK currency since the financial crisis of 2018.
This suggests that if a good piece of data were to cause a spike in the pound we could witness a huge amount of these negative bets forced to close. This would amount to a classic short-squeeze.
As these bets are closed traders are forced to buy up sterling ensuring it recovers.
Thus, any recovery in the GBP to USD exchange rate could potentially run further than would be the case were markets evenly balanced.
We are targetting a move to at least 1.46 which represents the upper trend line to the longer-term downtrend.
If longer-term valuation issues are to play a role going forward then they will certainly kick in longer-term.
Brexit Summit Next Week Could Boost the Pound
UK Prime Minister David Cameron takes his UK-in-Europe compromise to other EU leaders this week, hoping to convince them it doesn’t give the UK too special a status in the union, while hoping to convince the British public that it does.
GBP is likely to see sharp swings on rumours as the meeting gets underway.
Acceptance by other leaders should mean a June 2016 referendum.
