Mixed News and an Accidental Sterling Rally

Charlie Parker
Charlie Parker

As the Summer sun beats down on Europe it has not ‘burnt away the virus’ as some had hoped. Cases are rising again across the continent and there is some evidence that in the UK our ‘R’ rate has tipped just above 1 in some regions. 

It should be noted though that general population infection rates remain low and the growth rate is very modest. Whilst this underlines the unnerving reality that the virus is here until we have a vaccine, we do not believe it is likely to lead to the sort of mass lockdowns that can undermine the nascent economic recovery.

One of the challenges of this virus is that human beings are terrible at analysing risk. Many have become more reluctant to leave home in recent days as the UK virus news has got worse. The change the government has measured is based on its population survey which looks for the amount of the virus in general circulation. The latest data suggests 1 in 1,500 people in England have it. The rise in recent weeks has been from 0.05% of the population having it to 0.07% with a high degree of uncertainty. In fact, just 24 ‘more’ people in its survey were found to have it than last time but on the basis of this evidence we have become more cautious. Yes, the daily infection rates have risen too but they are highly susceptible to the availability of testing in a way the general population survey is not.

How on earth do we adjust our behaviours in response to such a statistical move? Is the change irrelevant or significant? It is impossible to say.

The bottom line is that unless you are entering a high risk institutional setting or are in a vulnerable group you are highly unlikely to get the virus out and about in England. However, whether the risk is worth taking – that is a highly individualised decision.

In the United States the news is better. Following two months of rapidly rising cases there is now evidence that, largely as a result of ordinary people ignoring the Federal government and taking their own precautions, it has now peaked.

There is also evidence within markets that investors are firmly of the view that whilst the economic recovery from here will be slow and faltering it will continue. The surge in the virus in the United States has not stopped this. One key effect of this is that the dollar is weakening as a currency. This happens at times when investors globally become more comfortable with the economic outlook. This dollar weakness in recent weakness has been accompanied by a surge in sterling.

This was partly driven by a more positive tone this week from the Bank of England. Whilst it was at pains to say that the economic recovery will be slow it also argued that the contraction would be less severe than had been thought. There was no more quantitative easing or interest rate cuts announced which could have been expected to weaken the pound.  The rally in the pound which followed this announcement is the last thing that the Bank of England wants though and will have been quite accidental.

Throughout the Covid crisis the pound weakened against the euro and the dollar and this helped our portfolios. It meant that our overseas assets rose faster in value and provided some support to help the FTSE rise here back at home.

However, it was trading at a particularly low price versus the dollar and the euro. It has now returned to something like its average price since the Brexit vote in 2016.

This volatility though in the value of our currency may well be something we have to get used to. Traditionally the pound has been seen as one of the most stable currencies in the world – part of the big five most traded and therefore most stable.

However, since the Brexit vote it has become meaningfully more volatile than its peers. This has led some leading analysts to say that should the UK fail to reach a deal with the EU on its trading relationship the pound will trade more like a good emerging market currency than a big stable G10 currency.

One thing is for sure whilst the pound has risen somewhat in recent weeks – which has held our portfolios back– it has not reached anything like the levels it traded at before the Brexit vote.

We continue to believe that over the long-term the pound will weaken. This continues a trend that has been in place since the 1970s but has been accelerated by the Brexit vote. Whilst there will be episodic rises such as that which we have seen in recent weeks we believe that trying to time currency markets in the short-term is a fool’s errand.

In the long-term it is hard to see how the pound, which is becoming less liquid than its peers, less heavily-traded and more representative of a single nation with a huge deficit and a modestly shrinking economy, can rally significantly.

But on the bright side you will be able to buy more Euros if you venture overseas this Summer.