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Our Pound-to-Dollar Rate Forecasts Were "Pumped Higher" to 1.40, in 2019, Say Unicredit

 

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The Dollar is overvalued and must fall whilst the Pound must rise since pressing the 'nuke' button of a 'no-deal' Brexit is simply not an option.

The Pound-to-Dollar exchange rate is forecast to rip curl higher in 2019, as a depreciating Dollar meets a strengthening Pound, says Unicredit Co-Head of Strategy Research Dr. Vasileios Gkionakis.

Unicredit's 'Back to Equilibrium' hypothesis, says that the Dollar is grossly overvalued (by about 10%) and will start to fall back down from here towards fair value, with a 5% depreciation in 2018 and another 5% in 2019.

Although the Federal Reserve has not yet finished raising interest rates and these are a positive driver for the Dollar (because they are a magnet for foreign capital in search of higher returns) history tells us that the Dollar tends to peak well before rates do, so according to Unicredit's forecasts its probably peaking right now.

"More often than not, the USD tends to peak at the beginning of the hiking cycle but starts depreciating as the target rate increases, most likely because of the growing maturity of the business cycle, in combination with tighter financial conditions, start weighing on growth and growth expectations at home," says Gkionakis.

The potential for a Dollar 'rush' on the back of tax 'reform' is over-egged, says Unicredit's Gkionakis - Tax Reform may provide some short-term upside but after a while, the market will start to discount its negative impact on the budget deficit.

Basically, the country cannot afford the tax cuts proposed so it will have to borrow the money from foreign investors to meet the gap.

The country's credit rating may also suffer as the already large debt burden increases, and eventually, this will impact on its attractiveness to outside investors: all these side-effects are Dollar-negative.

"Fundamentally, the widening of the deficit should actually be dollar-negative," concludes Gkionakis.

Sterling Rising

In contrast to their negative Dollar view, the FX team at Unicredit see the irresistible logic of negotiation leading to circumstances in which the Pound strengthens. 

The logic is as follows: the UK is more reliant on the EU for trade than vice versa so it is in the weaker negotiating position.

Because of this, the EU will wear the UK down to agreeing on a Brexit divorce bill, so as to get on to the next stage of talks about trade and to agree a 2-year transition period.

As the UK agrees to more and more of the EU conditions and a softer Brexit with a better trade deal attached begins to look more possible the Pound will rise.

"The end game is likely to be one in which both parties agree on a transition period so that the UK avoids dropping to the "void" from a cliff. Of course, it is unlikely to be plain sailing, but once we get there, this is likely to manifest as a stronger support for sterling," says Gkionakis.

The agreement of a transition period, in particular, should protect the Pound, with Unicredit forecasting GBP/USD to rally to 1.40 in Q1 2019.

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