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Sterling appears to be floating on hot air, is fully valued and at risk of a fall, says Simon Ward, an economist at asset manager Janus Henderson Investors.
He warns optimism over the vaccine rollout in the U.K. and sharp cuts in U.S. interest rates to mitigate the impact of COVID-19 have driven confidence to its highest level in over a decade. But he warns this meant the pound
GBPUSD,
is at risk of a fall.
The economist points to two indicators that show the rise in sterling is being driven by short-term speculation on capital, meaning it could be vulnerable. Every month, the Bank of England publishes data showing changes in foreign sterling deposits at U.K. banks and there has been a huge rise over the last 18 months.
The net deposit at U.K. banks by non-U.K. residents in the 18 months to December was £98 billion ($136 billion).
Read: The Pound is Headed to $1.50. The Covid-19 Vaccine Will Help It Get There.
Ward told MarketWatch in an interview on Friday: “That’s a very large increase by historical standards. I looked back and this was only matched just ahead of the global financial crisis (GFC). And the buildup then, obviously, preceded a collapse in sterling during the GFC, because that money went out as a result of the crisis.
“So that’s one piece of evidence, and then you can look at sterling positioning in the CME futures contract. The net long position, excluding commercials, is the largest since April 2018, again that preceded a fall in sterling.”
While not actually forecasting a fall, he is flagging that these elements suggest the pound is at risk of a sharp correction if the vaccine rollout program goes wrong or in the unlikely event the Federal Reserve lifts interest rates or slows its bond purchases.
Read: Bank of England makes no changes and says no tightening until ‘significant progress’ made
He cited bullish sentiment on sterling, which recently reached its highest level since 2009, according to a survey by research firm Consensus.
“Consistent with that Bank of England data, this again suggests that there’s been a big speculative inflow into sterling ,” he said. “While that doesn’t mean that sterling is about to collapse it’s certainly vulnerable to any bad news and could be floating on hot air,” he said. “I think the U.K. economy is going to be very strong for the remainder of this year.”
Normally, he said, a strong economy is bullish for a currency because people start to price in interest rate increases, but he thinks it will be different this time because central banks are all saying they are not going to raise rates for a very long time.
“So I’m not sure that a strong economy is bullish for a currency in this environment,” he said. “And what I’m concerned about is that the strength of domestic demand in the U.K. is going to suck in a lot of imports and we’ll see a big blow out in the current-account deficit over the next year or so. So for me that could be the trigger, or a change in sentiment towards sterling.”
