Complex Made Simple

The UK election and an anatomy of the coming sterling crisis!

Matein Khalid, veteran investor and Chief Investment Officer of Asas Capital in the DIFC breaks down the Pound Sterling situation and gives his forecast for what's to come for the currency.

I now believe that sterling’s breakout will be swift and spectacular to the upside after the 12 December UK general election The twin deficit/sterling collapse is a 2020 story For now, sterling is 18% undervalued on econometric models I trust

Trading sterling based on the eccentricities of UK polling data has been historically a mug’s game – an existential reality magnified by the traumatic fall in cable after the June 23 2016 shocker on the Brexit referendum. So I had a 1.30 target on my bullish sterling trade idea (recommended buy price 1.20), published in this media platform on 9 September 2019.

Investors who caught this stellar 10 big point move on sterling are welcome to consider hauling me to a celebratory currency gnome’s liquid dinner at a watering hole of my choice and toast me with a chorus of “He’s a jolly good fellow – sometimes he gets the bloody thing right”!

The risk of a hung parliament and botched Brexit has been visceral, a potential sword of Damocles over us sterling bulls. However, I now believe that sterling’s breakout will be swift and spectacular to the upside after the 12 December UK general election. Why?

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One, the Conservative Party’s opinion poll lead over labour is widening as the campaign reaches its endgame and I find the usual caveat about not trusting polls to be humbug.

Two, sterling is creeping up not just against the US dollar but also against other luminaries on its trade weighted index, notably the Euro.

Three, UK house price data for 2019 was better than consensus, even though consumer confidence has taken a predictable hit from the vagaries of Brexit. This exhaustion is also ballast for Boris Johnson’s bid to renew his lease on 10 Downing Street with the people’s mandate in the general election.

The British electorate is as exhausted as my tribe of Blighty/Vilayet watchers after all the twists and turns of Brexit/Westminster politics since June 2016. At least Boris Johnson has secured some sort of EU deal and priced out the no deal hard Brexit catastrophe option from cable. Surely that is sufficient for him to be summoned by Her Majesty the Queen to Buckingham Place to form the next government in her name. 

Four, I have been watching sterling volatility, option skews and positioning data like a hawk to exploit any real time gifts Mr. Market Esq. may bestow on me. Yet the range bound sterling volatility tells me that the financial markets are not worried that Jeremy Corbyn and his followers will seize power in London on December 12. The 12 digit opinion poll lead of the Tories now looks invincible, as all the political parties have unveiled their manifestos to the electorate. Ironically, the Tories and Labour have now squeezed out the smaller parties.

Five, despite its rise to 1.29, sterling is the most attractively valued G-10 currency on multiple metrics. Sure, black swans, protest votes, even turnouts on December 12 are all variables but I believe the political risk to the sterling bulls is now acceptable.

Six, I have lived with the correlation between sterling and Downing Street politics my entire adult life. I was able to persuade Daddy to allow me to head for America (Arizona State initially, in the aptly named Sin City, Tempe campus) with four high school cronies from Dubai rather than fly to dreary, rainy London of the Ghostown/early Maggie era. My argument?

Sterling had surged to 2.40 against the US dollar in late 1979 or 8.9 UAE dirhams after Mrs. Thatcher won the 1979 general election against Big Jim, the North Sea oil bonanza made Britain a petro-power at the precise moment the fall of the Shah of Iran caused oil prices to triple. The financial markets also lost confidence in the impotent anti-inflation strategies of the Carter White House.

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On 15 September 1992, Black Wednesday, sterling’s humiliating exit from the ERM was masterminded by George Soros and Stan Druckenmiller, The Quantum Fund made a billion dollar killing against the Bank of England and inflicted more damage on the British economy in a single afternoon than Göring’s Luftwaffe managed in the Blitz.

I saw this happen before my eyes in the Chase Manhattan Bank’s glass walled trading aerie in lower Manhattan. I could see the silhouette of the faux – Renaissance fortress – palazzo of the New York Fed from the glass widows as I frantically helped the spot sterling desk deal with the tsunami of hedge fund selling in the pound and the lira against the mark. This was the moment I finally understood what was meant by “Deutschland, Deutschland uber alles”.

In late November 2007, I wrote a press article and said sterling was comically overvalued at 2.10 cable, just before history’s biggest quid meltdown, bigger than even Harold Wilson’s “pound in your pocket” debacle in 1967 or Ramsay McDonald’s 1931 decision to take the British Empire off the gold standard. Sterling fell to 1.35 in the next year as Lehman died. Now I watch and wait for December 12 but all set to pull the trigger when the stars, dear Brutus, are finally aligned.

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My post election take on sterling? Boris Johnson’s win will trigger euphoria and a potential cable move to 1.36 – 1.38. Then the “gnomes of Zurich” (and DIFC!) will realise that the UK balance of payments deficit is above 5% of GDP – and headed south to the danger zone.

Untold billions of Chinese, Russian and Gulf Arab hot money no longer lubricates the once frothy, now mediocre London luxury house market. I had predicted disaster in Battersea/Nine Elms, the hideous “Hong Kong on the Thames” as far back as 2013. The politicians in Westminster have also unhinged HM Treasury’s fiscal prudence protocols.

Sterling does not price in a 3% to GDP fiscal deficit ratio and a giveaway Boris Budget sometime next year – but it will. Twin deficits and sterling crises are etched in my soul, especially if the High Street retail bust leads to recession or the left comes to power. 

The twin deficit/sterling collapse is a 2020 story. For now, sterling is 18% undervalued on econometric models I trust, not vulnerable to the exodus of hot money even if the Bank of England and HM Treasury botch an inflation bubble/public finance black hole, as they invariably do.

This prospect will limit the upside potential of cable as surely as it will precipitate the next sterling crisis, the seventh since 1967 (Wilson), 1976 (Callaghan’s IMF bailout for the Crown), 1992 (John Major and the ERM), 2008 (Gordon Brown’s bailout of Lloyds, RBS, HBOS) and 2016 (Old Etonian bungles Brexit debate) and 2019 (Old Etonian threatens/averts no deal hard Brexit). Yet as Lord Carrington so eloquently exclaimed, as long as the Queen is at Ascot, the Tories are in power, all’s well with the world!

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