THE HEDGEYE EDGE
On 8/13/14 we issued a buy signal on the GBP/USD (via the etf FXB) in our Real-Time Alerts with the cross reaching our immediate-term TRADE oversold level ($1.67) within our bullish long-term TAIL view (support = $1.65).
At the time of our signal the GBP/USD had corrected -2.2% M/M and took a leg down following the BoE’s release of its August Inflation Report. We believe the weakness reflected:
- UK wage growth that fell -0.2% in Q2 Y/Y (the first decline since 2009)
- BoE Governor Mark Carney rhetorically pushing out expectations for a rate hike to at least late 1H 2015 (though no specific guidance was given)
Despite the near term correction, the GBP/USD is up +12% since it troughed on 7/5/13 and we expect the cross to continue to be supported higher based on healthy underlying fundamentals into 2H, especially versus what we expect to be economic weakness (below consensus) and dovish policy out of the Eurozone and U.S.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
Over the intermediate term TREND, we expect strong fundamentals to drive a strong Pound:
- Low Unemployment: the UK unemployment rate to drop below 6.0% by year end (the most recent reading fell 10bps M/M to 6.4%, the lowest level since 2008)
- Strong Growth, especially versus peers: the BoE revised up its expectation for near-term growth to 3.5% in 2014 (vs ~1% for the Eurozone)
- Managed Inflation: the tax of inflation has moderate and CPI (currently at 1.9% Y/Y) is near the 2.0% target
On central bank policy, we expect a more dovish policy response from the ECB and Fed versus the BoE that should be supportive of the Pound versus the USD and EUR:
- Janet Yellen’s commentary suggests she remains an uber dove: (See Reuters article with current and former Fed officials indicating that Yellen and core decision-makers at the U.S. central bank are determined not to raise interest rates too early and risk hurting the fragile U.S. economy). We’ll be watching her Jackson Hole commentary beginning August 21 for a confirming dovish outlook.
- ECB’s Mario Draghi looks poised to issue QE over intermediate term. Following the June announcement of the issuance of the TLTRO programs to unlock lending, come Fall he may begin QE-lite purchases (via ABS). A hike in rates (after cutting in June) appears highly unlikely over the next year plus given underlying weak fundamentals and inflation expectations that are likely to miss on the downside.
Essential to our thesis on FXB is expectations around economic growth and the policy stance of central bankers. If and when these expectations shift, so will we, however under the current set-up, we expect the British Pound to be a relative winner, especially versus the USD and EUR.