(Bloomberg Opinion) -- The pound has been pummeled after Prime Minister Theresa May delayed the parliamentary vote on her Brexit withdrawal bill. But the ongoing weakness of sterling is not an assured one-way bet.
A lot of the bad news may well have been factored in, a point that Macquarie analysts have repeated in assessing that the pound is undervalued. So-called currency pairs like the pound-dollar and pound-euro are by definition relative bets; for one side to weaken it means the other strengthens. And recent headwinds for both the dollar and euro may naturally check sterling’s decline — and boost its upside if a Brexit deal miraculously were to appear.
The gilets jaunes’ protests in France have caused a pretty stunning volte face from President Emmanuel Macron, with more than 10 billion euros ($11.4 billion) of minimum wage and pension tax changes proposed this week. Alongside France’s already-announced reversal of a fuel tax rise, this could increase France’s deficit by as much as 0.6 percentage points to about 3.4 percent of gross domestic product. That would smash through the EU’s fabled 3 percent ceiling.
“Le spread” of 10-year French government bonds to German bunds has widened by 10 basis points in December, creating the biggest gap since Macron was elected in May 2017. It’s significant that this is now due to French yields rising rather than just falling less than bunds.
France is renewing its habit of honoring the EU’s fiscal rules more in the breach than the observance. Although how much of this is deemed “temporary” may save Macron from the ignominy of being hauled through the European Commission’s excess deficit procedure. Given that Italy is facing one for its 2.4 percent budget plan, double standards do seem to be at play.
The real risk for the euro is that populists across Europe will view Macron’s response as shattering the EU’s credibility on budget discipline. More intransigence from Rome can be expected and pressure is building in other member states for a lifting of austerity measures.
Meanwhile, the dollar is no longer a certain upward bet. Goldman Sachs Group Inc. has revised its expectation of a March hike from the Federal Reserve. Renowned hedge fund trader Paul Tudor Jones predicts no hikes at all in 2019. The market has cut the chances for the Fed’s metronomic quarterly tightening to still be in place by June to just 7 percent. It was 31 percent two months ago. Despite consistently strong economic data, the mood music from Fed chair Jerome Powell has changed — and with it the main prop for dollar strength is being taken away.
Sterling may seem friendless as the British government flails about trying to secure a palatable exit deal. But its best defense may be that it’s not alone in having to deal with crisis or thorny problems. Pound traders may care to put on a high-visibility vest in solidarity.
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Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
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