Full Circle: Will Cable Hit Pre-Brexit Levels in 2021?
Posted by Colin Lambert. Last updated: February 19, 2021
Sterling’s rebound from its peak pandemic lows has been one of the FX stories of the last year, and Stuart Cole, chief macro strategist at Equiti Capital, expects more good news…
Cable continues to move higher, trading some 22% higher since last March when it reached a post-EU referendum low of 1.1412. Some of this move higher reflects a softer US dollar sentiment; some is an improving Sterling narrative, but with Cable now expected to test 1.4000 soon, interest in how far this rally might go is mounting.
Equiti Capital’s baseline view is that Cable retains room to trade higher and we believe a realistic end-year target is for the pair to be trading back at its pre-EU referendum level around 1.4500. What is the reasoning behind our bullish view?
The key sterling positive since the beginning of this year has been the removal of Brexit related risk, with the UK’s departure from the EU so far proving to be something of a discrete, non-event. Predictions of economic collapse and national disaster have not played out. While red-tape and customs checks have hampered early cross-border trade, confidence remains high these issues will be overcome, with evidence already pointing to trade flows normalising. The Brexit uncertainty that weighed on the pound has receded to leave undervalued UK assets looking attractive to overseas investors, encouraging inflows back into the UK. Going forward, as new trading opportunities are opening up across the world, we see the UK becoming ever more attractive to international investors and Sterling to strengthen further as trade volumes grow to above pre-EU exit levels.
The success of the Covid vaccination programme, one of the fastest in the world, is boosting optimism the UK will emerge from its third national lockdown sooner rather than later and, crucially, ahead of its peers. As lockdown restrictions are lifted we anticipate – with the encouragement of the UK Government – the large stock of savings built up over the past year to provide a much needed boost to consumption, stimulating production and investment and helping the economy get back on the road to recovery sooner than was considered even at end-2020.
Sterling will continue to benefit from the pullback in interest rate cut expectations seen after the Bank of England communicated an effective dislike for negative rates at its February meeting. This has prompted the market to increase long Sterling positions (CFTC data shows net long positions to be at their highest since last March), a dynamic we expect to continue. Going forward we also believe there to be a risk of rates rising sooner than currently anticipated, if the expected end-of-lockdown spending spree fans inflationary pressures. This could see the BoE move ahead of the Federal Reserve and European Central Bank in terms of rate hike expectations, potentially providing a boost to Sterling.
Global growth will show increasing signs of recovery as Covid vaccination programmes are rolled out, providing a supportive platform for risk sentiment. This increasing risk tolerance will be to the detriment of the US dollar, as safe-haven demand diminishes, but will work in favour of higher Beta currencies such as Sterling.
Finally, compared to pre-EU referendum levels, Sterling remains undervalued against the US dollar and the euro, by approximately 7% and 14% respectively. We contend this points to Sterling continuing to exhibit an unjustified excessive weakness and concomitant potential to strengthen further.
With a target of 1.4500 by year-end, our trading strategy is adding to a long cable position on dips. Caveats exist however, principally that as we move through 2021 we expect domestic economic data to play an increasingly influential role, particularly as the US and EU begin to catch with the UK in terms of Covid vaccinations and the easing of lockdown restrictions. UK retail sales and CPI data – proxies for the strength of consumer demand post lockdown and a signal of BoE tightening – will be key variables we will be watching as the year progresses.
Stuart Cole is chief macro strategist at Equiti Capital and has over 25 years of experience in banking at FX working at institutions including the Bank of England, Bank of Scotland and Mizuho Bank.
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