A1 Trading Company

October 14, 2022

The Case Against the Pound

Michael J. Donoghue
The Case Against the Pound

Today (Friday, October 14th) has been full of historic and turbulent decisions within the United Kingdom. Chief among them include the official end of the Bank of England’s (BoE) emergency bond-buying intervention scheme, as well as Prime Minister (PM) Liz Truss’ decision to fire Kwasi Kwarteng from his role as Chancellor of the Exchequer. He had only served in the position less than six weeks; his time in office is the second shortest ever for a Chancellor. With the UK’s economy now taken off of monetary policy life support, and a former foreign minister named Jeremy Hunt now appointed the new Chancellor, both the BoE and the PM are hoping for a fresh start. However, GBP bearishness only looks ever more compelling; let’s explore five crucial points of consideration as we evaluate the case against the Pound.

1) No More BoE Intervention

Towards the end of September, following the now-former Chancellor’s ‘mini-budget’ announcement that included debt-financed plans for energy bill subsidies and stimulus via tax cuts, GBP plummeted in value. The selloff saw the Pound reach never-before-seen lows against the US Dollar, nearing parity; to contain the selloff and prevent an implosion of the UK’s financial system, the BoE jumped into action. Buying bonds in order to inject new liquidity and project some semblance of economic optimism for wary financial institutions, the monetary rescue mission has worked, at least to an extent. However, this program ends today; now that the BoE is withdrawing its palliative aid, there is ostensibly nothing preventing another GBP selloff.

2) PM Truss’ Untimely Vision

While PM Truss may be nominally taking steps in a better direction, e.g., walking back certain tax cut provisions and appointing a new Chancellor, these gestures may be more tokenistic than substantive. This is because her whole underlying vision for the UK’s economy is incongruent with current circumstances: attempting to use fiscal stimulus to spur growth in the midst of 40-year inflation highs is almost nonsensical, contrasting both Keynesian and Austrian theories on economics. Even if she affirms a couple budgetary changes, there are few signs that she is relenting from expansionary policy in general, the key catalyst that prompted the GBP selloff.

3) UK Energy Insecurity

A central component of GBP’s bearish fundamentals is the energy crisis the UK is facing, similar to that of mainland European countries. The crux of this problem is that Britain’s shockingly high inflation rate, currently 9.9% year-over-year, is not just due to economic overheating post-stimulus, but is also caused by restricted energy supply and high global prices in the aftermath of sanctions with Russia. This supply-side problem cannot be fixed with hawkish monetary policy, forcing the UK’s government to choose between partially subsidizing energy bills with money printing, or potentially letting energy costs increase manifold, devastating consumers. Neither of these solutions can solve the underlying issue, and both contribute to Pound weakness.

4) Post-Brexit Instability

Another risky factor underpinning the fragility embedded within the UK’s financial system is uncertainty post-Brexit. With trade policy still in a state of flux upon leaving the EU, the UK’s economy was already in a delicate position in the eyes of potential investors. Now the UK is facing the same crises without the extra layer of financial security that comes with being an EU member, all while it is still finding its new footing on the world stage. Market sentiment may continue to assess that British equities, bonds, and the Pound are thus too risky to go long on, opting to further short GBP and other securities instead.

5) Empirical Forex Data

The Case Against the Pound

On top of these bearish fundamentals, institutional sentiment and market activity currently corroborate a bleak outlook for the Pound. According to the most recent Commitments of Traders (COT) data, 68.53% of institutional traders are selling GBP against other currencies, an increase of 4.55% over the previous week. Because financial institutions contribute significantly to price action and market volatility in forex, this institutional GBP bearishness has reflected in the markets accordingly. As depicted in the GBP/USD chart above, we have yet to see a breakout to the upside above trendline resistance on the 1-day timeframe (though a higher low has been found at the 1.10 level, before the bond-buying scheme finished).

A Grim Conclusion

The Case Against the Pound

From the standpoint of both fundamentals and sentiment analysis (as well as some technical analysis), a return to GBP bearish momentum seems quite plausible. While the fate of GBP minor pairs appears to be less clear, A1 Trading’s EdgeFinder tool, a market scanner that offers helpful supplemental analysis, rates GBP/USD at a -6, earning a ‘strong sell’ signal.

Key Takeaways

• Today has been historically significant for the UK’s fragile economy: the Bank of England’s emergency bond-buying program wraps up, and Chancellor of the Exchequer Kwasi Kwarteng has been fired. The case for GBP bearishness is quite a compelling one.
• First, the Bank of England’s quick monetary intervention to save GBP from collapsing ends today. With their policy efforts having briefly saved the Pound from dire sentiment and fundamentals, the primary measure of security for GBP’s value in forex is now gone.
• Second, while UK Prime Minister Truss has made some budgetary concessions, such as walking back the extent of her tax cuts, her underlying policy agenda is barely changed. Considering her vision was the catalyst for the GBP selloff, this is bad news.
• Third, the UK faces an energy crisis similar to that of mainland Europe, forcing the government to choose between debt-financed subsidies or devasting, near-unaffordable energy bills. Neither option is good for GBP, nor can be fixed by curbing demand via rate hikes.
• Fourth, the problems afflicting the UK’s precarious financial system are exacerbated by post-Brexit difficulties. Without the extra layer of economic protection brought by the EU, financial markets may judge GBP and UK stocks and bonds to be too risky to buy.
• Fifth, besides fundamentals, institutional sentiment and price action appear to confirm this bearish narrative for GBP. Over 68% of institutional traders are now shorting GBP against other currencies, and GBP/USD has yet to break out above key resistance.
• In conclusion, at best the Pound does not appear to be worth buying; at worst, market conditions look incredibly bearish for the currency, and for the UK’s economy in general. Currently, GBP/USD receives a ‘strong sell’ signal from the A1 EdgeFinder as well.

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