Pound’s ‘Risk-on Imposter’ Behavior Makes Any Rally Vulnerable
(Bloomberg) -- The pound is behaving like a “risk-on imposter,” making it vulnerable to a reversal in sentiment.
That’s the view of strategists at HSBC Holdings Plc including Dominic Bunning, who say the relationship between sterling and risk sentiment has strengthened since Covid-19 roiled markets last year. As a result, it’s now performing much like traditional high-beta peers, such as the New Zealand, Australian and Canadian dollars and emerging-market currencies. An asset with a high beta tends to rise and fall more than the overall market.
The pound’s “role as a risk-on currency is not well deserved,” they said. “Our base case is that GBP underperforms G-10 FX this year as its weaker domestic drivers start to dominate the spurious risk-on behavior that has driven it to more elevated levels in recent months.”
It’s an indictment of how the market is looking to re-categorize the pound after the U.K. sealed a late trade agreement with the European Union in December, removing a key source of Brexit uncertainty that had driven the currency’s gyrations. Sterling still trades well below its pre-referendum range against both the dollar and euro.
The currency is the best performer among Group-of-10 counterparts this year, buoyed by the U.K.’s vaccination drive, which is among the most successful in the world. It rose the most in a week Thursday after the Bank of England said it does not intend to send a signal that negative rates are imminent-- a move that would likely weaken the currency. It traded 0.1% stronger at $1.3685 as of 8:06 a.m. in London.
“In fairness, GBP does have a slightly lower correlation with equities than other ‘risk-on’ currencies and some recent strength may be a reflection of relative vaccination speeds, not just risk,” HSBC strategists said. “Even so, GBP’s elevated correlation to risk appetite may become a hindrance as and when more focus is placed on idiosyncratic drivers of FX.”
Currencies like the loonie, Aussie and kiwi have strong positive correlations with other risky assets, such as equities. Also, variables including higher exports, growth rates and inflation help drive their performance. The pound scores well on inflation, but lags in the other categories, they said.
HSBC aren’t the only ones pointing to domestic issues proving a headwind for the pound’s resurgence. Strategists at Citigroup Inc. are also bearish on the pound, citing trade disruptions, a widening current-account deficit and under-priced political risk around another Scottish independence referendum.
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