Position: Long British Pound (FXB); Short US Dollar (UUP)
We’ve been vocal about the longer term benefit for economies that turn to austerity measures NOW to rein in bloated deficits. In making this call we’re by no means blind to the reality that over the intermediate term (1-3 years), austerity in forms such as higher consumption and income taxes, wage freezes, and job cuts (via trimming government positions and halting public works projects) should depress growth levels. This is the new reality!
Europe has already shown leadership in belt tightening, with the government of UK Prime Minister David Cameron holding the spotlight as lead horse. We believe the gains in both the British Pound versus the USD and the stabilization of the EUR versus the USD are the market’s bullish near-term reaction to Europe’s fiscal management. While Europe’s sovereign debt issues are far from rear-view, the next question on our plate is the US’s response to its own debt and deficit imbalances, which we’ll be addressing in our next monthly theme call.
For now, we’re analyzing the fundamental macro data as it comes in and comparing movements in the market to the political and economic policy throughout the global economies we follow. One notable data point released today was UK retail sales, which rose +0.7% month-over-month in June, and is showing an improving positive trend over the last three months. While we accredit this to the World Cup and promotional deals, the retail sales curve nevertheless looks very different in the US over the last three months (see chart below), a point worth highlighting.
Certainly, understanding the macro forces that influence economies is never an exact science. However, what stands out is that over the last months the jobless picture and consumer and presidential confidence have deteriorated in the US. Conversely, across the pond in the UK a marginal level of optimism has paralleled the change in political leadership in May and the fiscal tightening measures announced since. We’re by no means bulled up on UK equities (or we’d have a position) and are cautious about economic fundamentals in the back half of 2H10. What’s clear, however, is that the current divergence between US and UK economic policy is flashing a clear signal to us from a currency standpoint, namely the divergence between a strengthening Pound and deteriorating USD.
We stand behind our short call on the USD via the etf UUP and long call on the British Pound (FXB), which we initiated in our virtual portfolio on 6/7/10 and 7/12/10, respectively.