HSBC FX Strategy says GBP has been fixated on cyclical, rather than political or structural drivers; and believe this will change
In summary:
HSBC begin with a sensible warning ...
- Weaving political risk into a currency forecast is seldom easy. And it may be that the road to Brexit is so long, winding and uncertain that the market is unwilling or unable to express a coherent political view on the GBP
On cyclical drivers (monetary policy)
- Politics is a vital cog, one the FX market has arguably downplayed in 2017, preferring the more visible and intuitive tracking of cyclical drivers. The cycle may have felt especially pertinent as the market countenances a shift in monetary policy stance to a tightening bias from a loosening one.
- But the sole focus on interest rate differentials is a mistake, in our view. We believe this has led to an overly optimistic consensus for GBP-USD
- We believe the market will ... reconsider politics much more actively as the finish line for Article 50 negotiations looms into view.
HSBC say to "coalesce the myriad Brexit outcomes into three" possible scenarios:
1) Super-soft Brexit: GBP-USD at 1.45
2) Smooth and stable transition: GBP-USD at 1.30-1.35
3) No deal / cliff edge: GBP-USD at 1.10
And conclude:
- The FX market is saddled with the problem of how to interpret the incredibly complicated political drivers of GBP, and appears to be ignoring the problem, fixating on cyclical drivers instead. Clearly the outlook for the economy, inflation and the BoE are important considerations but the market is in danger of underplaying the vital element of political risk. By simplifying the potential Brexit outcomes, and blending their probabilities, it becomes possible to at least get a gauge of how divergent spot is from a given viewpoint on political risk. The market's apparent complacency reassures us that our pessimism on GBP - which we see falling to 1.26 versus the USD during 2018 - is not misplaced.
