Mayday for the dollar?

Two weeks ago Theresa May’s call for a snap election in the UK may have stunned Westminster but it also caught currency markets on the hop. The pound enjoyed one of its best days in a decade rallying to a six month high against the dollar. It has certainly been noticeable for US taxpayers in the UK with an interest in “Cable” – foreign exchange market jargon for the sterling: dollar exchange rate (GBPUSD). Ahead of the election announcement the market was trading round 1.25 and since then GBPUSD has been as high as c. 1.2950 and is still just above 1.29 at the time of writing. Back in the middle of March it was just above 1.21.

The impact may be felt not just in the present but going forwards as the mind set of some market participants undergoes a change from the post-Brexit sterling pessimism that was still prevalent a couple of months ago. Major banks who had been amongst the most bearish or pessimistic about the pound such as Deutsche Bank  or HSBC have since dramatically revised their shorter term forecasts upwards for GBPUSD.

The election announcement was described as a “game-changer for Brexit and sterling” by Deutsche pointing to the major political challenge facing the UK government with Brexit. That is, the need to negotiate and potentially make key compromises with the EU whilst holding a fragile working majority of just 17 in the House of Commons. By this thinking it left Theresa May beholden to a small Eurosceptic clique within her own party. Should she, as many expect, secure a substantial majority this would allow her as Prime Minister to negotiate from a position of domestic strength and unfettered by fringe or more extreme voices in parliament. Whilst the last year in global politics has reduced the confidence of many in the forecasts of pollsters and pundits, nevertheless financial markets appear to be confident that the election will deliver a large enough majority for the government to engage in negotiations without being undermined domestically. This could forge a “softer” Brexit deal and the kneejerk market reaction at the moment seems to be that a softer Brexit = a stronger pound and vice versa.

The narrative above may be compelling as an explanation for recent GBPUSD strength but it may just be part of the story. Speculative sterling short positions – whereby investors and traders had sold the pound in advance of what they expected to be further declines in its value – were at record levels in March as measured by CFTC data for the Futures market and history suggests that extreme speculative positioning is often subject to sharp reversals as new capital to commit to such positions dries up and when spooked market participants rush for the exit at the same time to close their positions. According to this viewpoint a huge amount of bad news had been priced in by this point for the pound and the election announcement acted as the trigger for traders to exit their trades.

Whatever the whys and wherefores what is certain is that for anyone converting money between dollars and sterling this is a material difference. When converting $100,000 into sterling at either 1.21 or 1.29 the cash difference in what you would now receive is meaningful at just over £5,000.

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