STERLING AT THREAT FROM A SELL OFF
BORIS SCHLOSSBERG
DIRECTOR OF CURRENCY RESEARCH, GFT
LAST week, economic data throughout the G10 was generally positive and supported the risk rally that saw most of the high beta currencies reach yearly highs against the dollar. But just as US traders prepared to sit down to a Thanksgiving meal, the unexpected news from Dubai quickly unwound those trades. This week the central theme revolves around this tension between the recovery bulls, who are anticipating further improvement in economic data, and the bears, who are betting that credit crunch fears will stifle any rebound.
In this tug of war between risk aversion and recovery, the pound stands the most to lose. This is for several reasons. First, UK financial institutions have the largest exposure to the Middle East, putting them at the greatest threat from any default or restructuring of Dubai World debts. Secondly, the UK economy remains highly dependent on the financial sector and any turbulence in global capital markets is likely to weigh negatively on sterling. Finally, to the extent that the situation in Dubai raises risk premiums across all debt markets, the UK government may find it more difficult to finance its deficits in the future.
For the time being, cable has weathered the storm relatively well, rebounding off the lows set last Friday. Yet I believe it remains vulnerable to further declines on resumption of risk aversion flows and any disappointment in economic data. One troubling piece of news was the latest GfK UK consumer confidence numbers, which declined sharply for the first time since January, suggesting a possible slowdown in activity. If UK PMI reports this week continue to miss expectations, market sentiment could turn sour and sterling-dollar 1.6000 could quickly come into view.
Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail them at [email protected].