Are we really dealing with a weak GBP?
September 27, 2022
All the talk in the markets at the moment is about the plunging GBP. Is that really the case?
Weak pound hysteria
Firstly, contrary to what every newspaper in the land is telling you, we are dealing with a strong dollar problem more than we are dealing with a weak pound problem.
The pound is weak by definition, as are 90% of the other currencies around the world as the dollar is decimating everything in its path.
There is no hiding from the fact that the pound dropped dramatically against the dollar last week, but would it surprise you to know that it wasn’t even the worst performing currency in Europe? The Swedish Krona fell even more.
Was this because of a stimulus package announced by their government? Or maybe the papers would argue that the global stock market dropped and every currency in the world fell against the dollar because of a speech made by Kwasi Kwarteng.
Of course that is not the case, but if you’re not watching global markets then it’s very easy to internalise the situation which seems to be what we’re doing in the UK.
So, let’s look at the facts. The Federal Reserve in the US is in charge of setting rates for the largest economy in the world. The impact from what they do is huge, and we have no control over it.
They have raised rates by 3.00% so far in 2022 and there is more to come. The result? Currencies across the globe have been decimated by a strong dollar.
So, how does the GBP/USD compare to other major currencies from around the world over the last 12 months?
USD/TRY (Turkish Lira) 109.24%
USD/PKR (Pakistan) 38.8%
USD/HUF (Hungary) 37.81%
USD/JPY (Japan) 29.80%
USD/SEK (Sweden) 29.11%
USD/PLN (Poland) 25.04%
USD/NOK (Norway) 24.37%
USD/CLP (Chile) 23.80%
USD/KRW (South Korea) 21.09%
USD/DKK (Denmark) 20.99%
USD/GBP (UK) 20.80%
USD/EUR (Euro) 17.33%
The Dollar Index is up 21.30%. The GBP is below the average. Once again, this is a dollar strength rally NOT a significant pound weakness. Yes, the recent move and the tax cuts haven’t helped, but they are not the main cause of something that started a year ago.
The USDX is a measure of the value of the US dollar relative to a basket of major foreign currencies considered to be America’s most significant trading partners.
As you can see, the pound has performed roughly as we would expect compared to other currencies.
In practice, currencies weaken and strengthen against each other for a variety of reasons, and economic fundamentals do play a primary role.
Fundamentally weak currencies often share some common traits. This can include a high rate of inflation, (very relevant at the moment), chronic current account and budget deficits, and sluggish economic growth. This all sounds pretty familiar.
Nations with weak currencies may also have much higher levels of imports compared to exports, resulting in more supply than demand for such currencies on international foreign exchange markets. While a temporary weak phase in a major currency provides a pricing advantage to its exporters, this advantage can be wiped out by other systematic issues.
Like most assets, a currency is ruled by supply and demand. When the demand for something goes up, so does the price. If most people convert their currencies into dollars, the price of the dollar goes up, and it becomes a strong currency. This is what we are seeing today.
Currency is, after all, a type of commodity.
A weak currency may help a country's exports gain market share when its goods are less expensive compared to goods priced in stronger currencies. The increase in sales may boost economic growth and jobs while increasing profits for companies conducting business in foreign markets.
For example, when purchasing British-made items becomes less expensive than buying from other countries, British exports tend to increase. In contrast, when the value of the pound strengthens against other currencies, exporters face greater challenges selling British-made products overseas.
Currency strength or weakness can be self-correcting. Because more of a weak currency is needed when buying the same amount of goods priced in a stronger currency, inflation will climb as nations import goods from countries with stronger currencies. Eventually, the currency discount may spur more exports and improve the domestic economy, provided there are no systematic issues weakening the currency.
We need the Federal Reserve to slow down the rate hiking process. If they don’t, the dollar will continue to strengthen. But why are we so worried about that anyway? Unless you own an importing business, or holiday a lot in the US, the impact on most of your lives will be minimal.
A weak pound is actually no bad thing for the FTSE100 which makes a large portion of profits in the US.
As the chart below shows, 71% of revenues generated by FTSE 100 companies come from outside the UK. The strength/weakness of sterling against the euro is also important given the large chunks of revenue accounted for by France, Germany, Italy and other eurozone countries.
The inner ring illustrates that 97% of the companies on the FTSE 100 have registered head offices (i.e. they are domiciled) in the UK.
The outer ring is the important part. It shows the regions from which FTSE 100 companies generate their revenues. All but 28.9% are generated outside the UK.
The mini-budget was perhaps a little irresponsible at a time when monetary policy needs to be closely managed; BUT, when was stimulus ever bad? Who knows, it might even increase growth at a time it is needed most. Shouldn’t we give it a chance?
The price of GBP/USD did move on the back of it, and we could have done without that, but it merely added to a problem that was already there.
Supply and demand will sort itself out over time and that applies to currencies as well. Too much interfering tends to just create other issues, but this is one lesson we never seem to learn.
The market is now pricing in a 200-basis point move by the end of November. That is 2%. I would be much more worried about that than what the pound is worth against the dollar. I also think the market has got carried away and is expecting too much as it often does.
It has been volatile, it may continue to be, but over the mid term- we fully expect our trading teams positions will prove to be the right one's. Most have been buying into a falling market. Yes, it's moved more than we would like (or expect)- but by maintaining their stance- they'll be rewarded in time. Nobody ever said trading was easy, particularly not in a year like this one, but have faith in the fact that we only work with experienced professionals who have witnessed periods like this before.
Enjoy your Evening.
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