GBP is one of the currencies most vulnerable to COVID -19, not only because the damage to public finances is larger than most other countries (a 2020 fiscal deficit of 16% of GDP). This reliance on inflows renders GBP more vulnerable to the depressing effect on yields from the BoE’s QE (now 14% of GDP this week); not only that, it will be interesting to see how a current account deficit currency such as GBP copes with negative rates if the BoE does indeed decide to push the policy envelope in that direction later this year. GBP is liable to become ever -more idiosyncratic as the UK nears the business end of the entire Brexit process and the market tries to benchmark the potential outcomes and eventually shifts from valuing GBP on a probability weighted basis to pricing a central scenario and then the outcome itself. Assessing what GBP would do in each of the three main scenarios - no trade deal; a bare bone deal for a limited portion of the goods sector; and a full -blown FTA that would eventually encompass the services sector – requires an assessment of the current risk premium in GBP.
We often use the REER as a valuation proxy but suspect this overstates the risk premium (GBP's REER is 12% below it 20Y average). A better indication is likely to be the undervaluation in GBP based on the interest rate relationship that prevailed up till the referendum. This approach indicates a 5% risk premium.
As such it tends to underscore our assessment that there is more downside for GBP on a no -deal outcome (cable to test the 1.15 lows again) than (upside on a trade deal (low 1.30s?), “Who could have imagined that spring 2020 would turn out like this?” Nobody probably, is what we would like to reply to the vice governor of the Riksbank Henry Ohlsson. Following the turbulent past months the Executive Board will be able to take a breather at Wednesday’s meeting, we do not see urgent need for action. In view of the first signs of an economic recovery the six members of the Board will presumably evaluate the situation first, adjust the very pessimistic April growth scenarios of -6.9% and -9.7% respectively and lower their inflation outlook.
However, the collapse of consumer prices as a result of covid-19 is unlikely to be overinterpreted either. As a result, we expect the Swedish central bank to stick to its current strategy, i.e. it will not lower interest rates back into negative territory. Other unconventional measures in the fight against the negative effects of the corona pandemic also seem unnecessary to us at present, so far the banks received an additional SEK 500bn in liquidity for lending purposes while the central bank also initiated an SEK 300bn program for the purchase of corporate bonds. Only a part of this has been used so far. However, it would seem that the Riksbank wants to keep all doors open on that front as uncertainty about the future economic recovery remains high. Everything all told it is likely to be difficult for the Swedish krona to benefit from Riksbank’s decision. It is already trading at pre-crisis levels again, a large share of optimism is already priced in. It is likely to be difficult to exceed that.
Long EURGBP from 0.895. Marked at 1.13%.
Unwind short GBPSEK at 11.678 with a stop at 11.950. Marked at +0.26%.
Sell GBPCHF at 1.176 with a stop loss at 1.205. Courtesy: JPM