The pound sterling continues to be the weak link amongst developed market currencies sliding to multi- year lows versus the US dollar. Having spoken to a number of experienced market participants the consensus among them is that a fall below 1.40 is very likely in the near term for GBP/USD, I’m not sure I want to disagree with them! The point is that this seems to be quite specific to sterling at the moment and you can see it from the way EUR/GBP has rallied since mid-December. It’s up 8.5%!! My take on this is that as the FOMC were pushing for an interest rate hike, the Bank of England under Governor Carney have opted to stay firmly on the side-lines. It has not been so clear to him that there is any need to exit the era of extraordinary monetary policy and in a sense I can understand this. After all the UK is not a continental super-economy in its own right with the ability to weather global economic storms and more specifically the turbulence coming out of China. The UK economy is much much smaller than that of the United States and it is far more open to global trade flows. Furthermore, the UK, not having a reserve currency is not able to rely on generous investors holding on to its sovereign debt. As I mentioned some months ago, the UK has turned from being a net owner of foreign assets to deficit. Largely brought on by the huge amount of debt issuance in the wake of the global financial crisis. This means that as interest rates rise in the UK there are likely to outflows, and more crucially it makes the UK’s external position extremely vulnerable. I believe these are the considerations exercising the MPC, and they’ve been lucky that falling energy prices and deflationary headwinds from China have given them cover to maintain their monetary policy stance. The nightmare scenario is if inflation rears its ugly head in the UK and forces their hand, the UK gilts market could be smashed and it would lead to a currency crisis. Of course we’ll keep you all updated if we think this is a serious risk.
Elsewhere Brent crude has now traded below $30 a few times, it’s likely to spend a long time under that key level, and strategists at some of the larger investment banks are already talking about $20 oil. Great news for consumers but an unfolding disaster for commodity exporters. I wouldn’t exactly call these economies – the likes of Russia, Venezuela and Nigeria spring to mind – sinking ships but there are likely to be extremely tough years in front for some of these countries and their currencies are reflecting this already. The announcement that the Nigerian central bank, CBN, will no longer supply dollars to bureau de changes is excellent news as something needed to be done to stem the bleeding of reserves, but it’s only a small step in the right direction. As things stand the market will determine where the parallel market rate goes from here. I hate to say it but things could get dramatically worse for the naira before any stabilisation occurs. After all there needs to be buyers of the naira for it to turn around. The CBN was the biggest buyer and they’ve left the building, work it all out for yourselves. For things to turn around, investors have to feel that the Nigerian government has got a credible economic policy in place that will enable businesses to make the long term investment decisions that will be necessary for recovery. I’ll only observe, having spent Christmas in Lagos that walking through a Shoprite shopping mall which was as large as any mall I’ve been to in the UK outside of Westfields. It was difficult to move around for the amount of footfall. There is a vibrant consumer culture there and clearly money to be spent. The smart guys surely know this and I can imagine a stampede to get in on the action in Nigeria once investor confidence is improved. Something to watch out for. The CBN letting go of the illusion of the official exchange rate would be a step in the right direction, but I’m not sure they have the conviction to do that yet.
This has been an ugly start to the year for equity markets with the S&P 500 down almost 10% already. Still I am yet to be convinced that this is the ‘end times’. I could easily see this market dropping a little bit more before a recovery gathers strength. For now I am watching the low 1800 levels as the key support area from which the green shoots of recovery should spring. It seems clear that it will be extremely difficult for the Federal Reserve to be as aggressive with tightening as their December forecasts seemed to imply. But I remain convinced that the key data points to watch out for in 2016 will be the strength of the US labour market, particularly wage growth. Manufacturing already seems to be in contraction mode, no doubt due to the strength of the greenback, it’s hard to see FOMC members jumping to tighten. If there’s one thing central bankers hate, it’s to be forced to undo what they’ve only recently done. The only question is, will the market eventually start reflecting this reality in the dollar? Perhaps it already is, as both the euro and Japanese yen are actually holding up quite well versus the dollar at the moment. The weak links are where we are seeing crises – Emerging markets – or the potential for crisis… the UK.
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