Amongst the winners of the pandemic have been Gold, the Euro and increasingly the Pound Sterling. Sure, the first two have reached their highest rates in one case ever and in the other for several years but for the Pound to have eliminated all of its losses for the year against a backdrop of increasing political and economic uncertainty is either impressive or insane. Strong risk appetite across markets is contributing to fears of a dissonance between valuations and fundamentals. The clash between reality and financial markets is emphasised as we reflect upon the global stock market’s performance. With the world’s equities having enjoyed their best month since 1986, we ask is this just a very steep V-shaped recovery or a market running before it walks again.
In the case of the Pound there is reason to have caution over its impressive rise. Despite a rising spot price since the first few weeks of the pandemic, speculative positioning has remained largely static with a severe short bias. This means that periods of market turbulence and in particular GBP-positive remarks or data can have a bigger punch than normal as investors are squeezed out of this short position. Whilst this effect can push Sterling considerably higher it can also encourage higher volatility and create choppy GBP conditions.
Whilst we await the data to confirm the change in positioning, we have seen this effect take place last week. On Friday Bank of England Governor Andrew Bailey took his opportunity to speak at the virtual Jackson Hole symposium. The take away message of his speech was that the Bank of England has considerably more firepower left in terms of its monetary policy toolkit than either the market or the Bank appeared to have believed. This leaves us with a mixed conclusion: either the Bank is suggesting it can and therefore perhaps will target looser monetary policy to encourage growth, or, the bank is comfortable in its capacity to deal with an economic downturn should a second wave of the virus his the economy. Both are credible interpretations of the Governor’s comments but the market’s short exposure to Sterling likely encouraged defensive positioning with demand for the Pound rising on the day.
The momentum behind the Pound continued over the bank holiday with thin liquidity in markets. With infection rates rising across Europe, the deadline for a Brexit deal and the US election creeping ever closer markets might conclude that valuations have gone too far too soon and stage a correction in these assets.
Discussion and Analysis by Charles Porter