We published a bullish view on the British Pound today on Seeking Alpha. Below are some excerpts:
- GBPUSD looks to be breaking out of its short-term downtrend and real yield spreads suggest the paid should be trading significantly higher.
- There is potential for a virtuous cycle where a stronger pound reduces inflation expectations which in turn raises real bond yields and puts further upside pressure on the pound.
- Cheap valuations suggest downside risks are limited, but the country’s chronically low savings rate would have to rise in order for significant long-term appreciation to ensue.
“The pound has long-been undermined by its deeply negative real interest rate situation. U.K. inflation-linked bond yields (the difference between nominal yields and market-implied inflation expectations) have been deeply depressed thanks to a combination of low interest rate expectations and high inflation expectations. In part this reflects the fact that inflation-linked bond payments are linked to RPI rather than CPI, which tends to average roughly a percentage point higher. Even accounting for this though the trend of real yields has been unfavorable to the pound, until now.”
“The spread of U.S. over U.K. inflation linked bond yields has moved dramatically in the U.K.’s favor over the past six months, receiving renewed upside momentum from the recent collapse in U.S. rate expectations. Based on the correlation between real yield spreads and GBPUSD, the pair should be trading significantly higher.”
“While U.K. bond yields face downside pressures from slowing growth and rising financial risks, we expect inflation expectations to fall further, putting upside pressure on real yields. In contrast to fears over Brexit which were market by rising inflation expectations we expect coronavirus concerns to prove disinflationary, at least in the short term. 10-year U.K. breakevens have already begun to trade lower and the trend is clearly downwards.”
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