Will Sterling Continue to Strengthen Against the US Dollar?

Investors are becoming more bullish on the pound, leading contrarians to row back their positivity. Does the currency have further to go?

David Brenchley 27 March, 2018 | 10:36AM
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Last week’s announcement of a Brexit transition deal between the UK and European Union was seen as a seminal moment in negotiations by many. As expected, sterling responded positively, jumping 1% to 1.4141 against the US dollar immediately after the news.

It strengthened further to trade at 1.4208 on Monday afternoon. Now, some commentators think the pound’s winning run will continue, with some as bullish as suggesting 1.48. However, there was a note of caution on taking Brexit progress too positively from one quarter.

Clearly, concerns over the UK’s economic future outside of the EU has been front and centre of investors’ minds for a long time now. We’ve seen appetite for UK assets wane considerably as a result.

But the deal, which means the UK will be bound by all EU rules and regulations until 31 December 2020, changed that where the currency is concerned. It should mean the UK’s exit from the EU will be more orderly and give companies more time to prepare for life outside the Union.

Dickie Hodges, manager of the Nomura Global Dynamic Bond Fund, says he’s always envisioned the deal coming through, as it did, after the German and Italian elections. He says this is due to the EU not wanting to “give any credence to the far-right political activists within Europe during the Brexit negotiations”. He continued: “They wanted to show strength ahead of all the elections we saw in 2017 early 2018.”

Further To Go For The Pound

On that note, Hodges thinks the pound should continue to rally, so long as improvements in negotiations continue to filter through. “I think you need constant positive affirmation to come through for the pound to continue to go higher every single day.” He considers 1.45 against the US dollar to be an achievable target.

Others agree, with Dean Turner, economist at UBS Wealth Management, even more bullish with a target of 1.48 within the next 12 months. He notes the currency received a further filip from the relatively robust labour market report. Further, interest rates are likely to rise in May.

“Moreover, with downside risks relating to Brexit fading, we expect that decent economic data will keep the Bank of England in a hawkish mood, which should further support the pound in the months ahead,” he adds.

Another reason to be positive on sterling – in the short term, at least – is seasonality, according to Paul Ciana, technical strategist at Bank of America Merrill Lynch. Ciana notes that the pound has rallied against the US dollar in April in every single year for the past 14 years.

“This remarkable outperformance covers major events such as the financials crisis, general elections and the Brexit referendum, and suggests to us a consistently strong underlying flow which has trumped these idiosyncratic factors,” he continues.

“A combination of the end-start of the UK tax year and a heavy month of dividend payments by UK corporates are factors which we think are at play driving GBP strength during April.”

Bearish Voices

Morningstar Investment Management has long been positive on the case for sterling. However, Matthias Palowski, associate portfolio manager at MIM, says the team have become less bullish recently.

As contrarian investors, the team were happy to take a positive view on the GBP/USD exchange rate when others were negative on the currency. The pound was the cheapest it had been in 25 years. “We took quite large positions across the MIM portfolios globally, not only in the UK,” Palowski says.

However, as sentiment amongst other market participants has begun to reverse, thus MIM have become “somewhat less bullish”. “The pound went from around 1.20 to above 1.42; it means valuation is by no means extreme anymore.” Infact, adjusting for the dollar’s expensiveness against other currencies, “the pound probably trades within a reasonable margin of fair value”, adds Palowski.

The team is currently reviewing its case for sterling, and it’s something Hodges accepts. He expects the pound to dip slightly before it continues rising. “There’s a lot of optimism priced in,” he explains.

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk