Granite Wealth Management

View from the UK: What Does the Pound Say?

While currency movements can be tricky to predict on a fundamental basis, many view a currency’s strength or weakness as indicative of that country’s economic prospects.

If judging by the continued economic pessimism being voiced by British citizens, the Pound would be in for a world of hurt. Indeed, some of the comments I heard just last night at dinner with a handful of Brits include:

–        The divide between the haves and the have-nots grows wider.

–        The tax system kills risk taking and entrepreneurialism.

–        The need for housing is overwhelming, particularly for the immigrant population.

–        Covid has taken its toll on many small businesses which have never reopened. Meanwhile, the welfare system never rolled back the Covid handouts.

Most surprising to me was the skepticism towards capitalism, where the attitude frequently is that wealth has been achieved through gaming the system. One can see in these sentiments a mix of political viewpoints, often conflicting ones, from a populace that broadly sees its society heading down the wrong path.

So, I say again: this sounds like trouble for the Pound.

Interestingly, despite the Federal Reserve’s persistent interest rate hiking policy, it is the US dollar index that has dropped nearly 12% over the last year – an outcome few would have predicted ahead of a Fed tightening cycle.

That doesn’t stop the pessimism toward England’s currency, however.

The financial media sees all the same issues, highlighted by a Bloomberg article from just a few days ago, “Pound’s Glory Days Are Over as Bets on Ever-Higher Rates Fade.”

The Bloomberg article says “It all makes the pound much less compelling to investors who seek out currencies that offer a high carry — or the gain obtained from differing interest rates — as well as strong economic growth. UK housing prices are falling fast and a gauge of manufacturing data is at recessionary levels.”

“Sterling investors will start to price in an increasingly gloomy economic outlook,” said Luca Paolini, chief strategist at Pictet Asset Management. “Economic surprises have become increasingly less positive and run the risk of being outright disappointing in the coming months.”

Beyond the financial press, the investment industry shares this dour currency outlook. Pictet Asset Management, a leading British investment firm for over 200 years,  downgraded the Pound to underweight from neutral last week, citing a gloomy outlook for the UK economy.

Earlier in this post, I referenced the weak performance of the U.S. Dollar index over the past year. The British pound only makes up about 12% of the US dollar index, so it might be helpful to isolate the pound versus the dollar when trying to determine each currency might go next. Here’s a Point and Figure chart of the Pound/Dollar cross rate:

Remember, numbers in a P&F chart represent months. With this in mind, one can see the Pound has enjoyed a strong 2023 vs. the Dollar, particularly since its March low (represented by the number 3).

Despite the Pound’s pullback (column of O’s) over the past month, the trend at this point remains healthy. No breakdown has occurred as each pullback since early this year has registered a higher low.

Perhaps the pound’s unexpected rally this year has finally run out of steam as the Bank of England moves closer to wrapping up its tightening cycle. But most suspect our own Federal Reserve is nearing the end of its hiking campaign, as well.

Rather than trying to predict where either currency will go next based solely on the fundamentals, here’s what it would take to turn the Pound bearish: A reversal of the 3 consecutive upside breakouts we’ve seen since March. Put differently, a breakdown of support at 1.2516 (lower column of O’s) would be a worrisome sign that matches all the negative rhetoric.

Conversely, if the pound rebounded, respected support at 1.2642 and headed higher, investors should ignore all the negativity they’re hearing and remain bullish on the prospects for Britain’s currency.

Sometimes stocks, bonds or other investments sit in a clearly bullish or bearish posture. At others, as in this case, an asset class can be near an inflection point. I believe we’re near one with regard to these two important global currencies.

We don’t have to predict with certainty what comes next. Let’s wait and let the wisdom of the markets show us clearly whether the Pound is finally ready to fall the way so many are predicting.