A tumbling pound might initially seem like a bad thing, fatalist headlines are suggesting we’re headed for recession, while the ‘no-deal’ Brexit headings are giving rise to panic.
But what if there are some positives to take from a falling pound? Spurred on by the arduous and unceasing Brexit discussions sterling is really taking a hit, but can everything be blamed on Brexit?
Sterling dropped to its lowest point against the euro in 10-years on Monday as traders in Asia read that MPs may be unable to prevent a no-deal Brexit. Sterling hit an intraday low of €1.0724, according to Bloomberg data, which was lower than its post-Brexit drop.
Once the UK opened trading sterling rose again. And it’s here that we should be paying attention.
Sterling has historically gone up and down. The chart below shows GBP/EUR over the past 11 years or so and – as history and common sense dictate – what goes down must come back up.
Weak currencies mean that the costs for exporters fall while imports become more expensive. This means that production gets a boost, while consumers start focusing on the home-grown stuff (no need to point out the obvious when it comes to the impact this could have on Brexit). Yet there is another reason to welcome a fall in sterling. Look at the chart of the exchange rate between sterling and the dollar over the past half century and two things are clear.
The Spectator reports that: “Over time, sterling has adjusted downwards against the dollar because it is depreciating relative to the value of goods, services, salaries and assets in Britain at a fast rate than the dollar is depreciating relative to goods, services, salaries and assets in the US….The second observation is more subtle. Imprinted on the long-term downwards curve in the value of sterling is pattern of peaks and troughs. Look at where the peaks occur and the troughs occur and they tell an interesting story.”
The graph below shows when the peaks occurred - March 1975, October 1980, January 1991 and December 2007. There were flatter and less significant peaks in September 1998 and June 2014. The troughs, on the other hand, occurred in November 1976, March 1985, February 1993, June 2001 and February 2009.
“What do these dates have in common? The peaks have tended to occur shortly before recessions – and the troughs shortly before economic booms, or at least periods where the economy recovered,” it reports.
Source: The Spectator https://blogs.spectator.co.uk/2019/07/a-weak-pound-is-nothing-to-fear/
However, the GBP continues to be the G10’s worst performer as investors are pricing in a higher probability of a No-Deal. At the most recent monetary policy meeting on August 1, the Bank of England governor Mark Carney re-iterated that UK’s investment was falling, and the perceived chance of a No-Deal Brexit had risen which would have an adverse effect on the pound and UK growth.
But forex market remains an important one as it ultimately forms the basis of international trade and global investing. For example, most commodities are priced in USD, but investors from all over the world trade commodities, meaning there is a need for currency exchange. Forex trading also support imports and exports, which in turn creates additional demand for goods and services.
It also has the benefit of being a market in its own right, meaning investors can trade currencies for no other reason than to generate returns.
To this end currencies are generally traded in pairs. There are 28 pairs that can be traded but it is dominated by a handful of big currency pairs and these include predominantly US dollar led pairs such as: EUR/USD, USD/JPY, GBP/USD, USD/CHF, AUD/USD, USD/CAD and NZD/USD , according to ETX Capital.
By most estimates these seven forex pairs account for around 80% of global FX trading volume.
GBP/USD is one of the most popular forex markets traded with an uptick in trading opportunities over the past few years presented by the market uncertainty around major events like Brexit and the election of Donald Trump.
Unsurprisingly the other GBP focused pair that has created many trading opportunities is GBP/EUR. It is sometimes referred to as the ‘Chunnel’ in reference to the Eurotunnel.
You can trade currency pairs as spread bets, CFDs and also in ETP form.
Currencies aren’t considered ETFs but instead fall into the ETP category –known as exchange-traded currencies - because they are considered secured debt securities. Under UCITS they are eligible, not compliant.
Aneeka Gupta, Associate Director – Research, WisdomTree, says: “Short bets against the UK Currency (GBP) have risen to their highest level in more than two years as the possibility of a No-Deal Brexit has risen considerably ever since Boris Johnson took over as UK’s new prime minister.
“While we expect the pound to face significant weakness in the short term in the run up to the October 31 Brexit deadline, it remains attractive for investors over a long-term horizon. To offset the weakness from investors domestic portfolios, GBP linked currency ETCs would provide an attractive way to hedge some of the risk.”
One of the best performing sterling ETCs in the last three months has been ETF Securities ETFS 5x Long USD Short GBP (USP5). The ETC has returned over 43% in the last three months. The hefty return is largely a result of the 5x leverage factor it’s exposed to. The non-leveraged equivalent ETC ETFS Long USD Short GBP (GBUS) returned 7.6% over that time.
But using leverage comes with risks not least that it magnifies losses. What’s more, with daily rebalancing, the performance of the ETC and the underlying currency may diverge. When using leverage it’s important to understand the market properly, how it works, what factors impact it and when to get in and out of it to help cut losses.
Another thing to be aware of is the currency the pair is being traded in. This can impact how big the return is. For example, ETFS Short GBP Long USD (USD2) is in sterling and has returned 16% in the three-month time frame, while ETFS Short GBP Long USD (SGBP) – in USD – has returned 8% over the same time horizon.
We have listed some of the variations on GBP/EUR and GBP/USD ETCs below and their performance over the last three months.
ETF3M RTNTERINDEX/UNDERLYINGETFS Long GBP Short USD-7.03%0.39%MSFXSM Long British Pound IndexETFS 3x Long GBP Short USD-20.74%0.98%MSFXSM Triple Long British Pound IndexETFS Long GBP Short USD-0.16%0.39%MSFXSM Long British Pound IndexETFS Short GBP Long USD8.04%0.39%MSFXSM Short British Pound IndexETFS 3x Short GBP Long USD24.51%0.98%MSFXSM Triple Short British Pound IndexETFS Short GBP Long USD16.02%0.39%MSFXSM Short British Pound IndexETFS 3x Long USD Short GBP24.46%0.98%MSFXSM Triple Long US Dollar/GBP IndexETFS 5x Long USD Short GBP43.22%0.98%MSCEGUXL 5X Long USD/British Pound IndexETFS Short USD Long GBP-7.65%0.39%MSFX Short US Dollar/GBP IndexETFS 3x Short USD Long GBP-21.56%0.98%MSFXSM Triple Short US Dollar/GBP IndexETFS 5x Short EUR Long GBP-29.33%0.98%MSCEGEXS 5X Short Euro/British Pound IndexETFS Long EUR Short GBP6.49%0.39%MSFX Long Euro/GBP Index