Some Thoughts on Sterling

Pile of pound coins.jpg

The sterling rally from $1.40 to $1.50 in the week following Cox’s murder was understandable to us.  The assassination broke the momentum that we also recognized had been building in favor of Brexit.  But to catch that move meant leaning the wrong way on the Brexit results. 

Sterling approached $1.3120 in North America on Monday.  It closed last week near $1.3680.  It had hit a low of nearly $1.3230 in Asia as the referendum’s results became obvious.  Some had blamed the magnitude of sterling’s drop to thin market conditions.  The steep loss today to new lows warns something more ominous may be afoot.

The only think that seems to compare with the Tory Party’s seeming cluelessness on how to proceed is the disarray of the Labour Party.  The 229 Labour MPs will have a confidence vote on their leader Corbyn.  The results will likely be known toward the end of the business day in London Tuesday. The vote is advisory in nature, but the more that vote against Corbyn, of course, the more precarious his position.

Barring Corbyn’s resignation, which seems highly unlikely, a way to ensure a leadership challenge is for at least 20% of the Labour MPs (45) to sign a letter endorsing another candidate.  In such a challenge, Corbyn will likely run again and he could win.  Last year, Corbyn won a landslide from party members.  The rank and file was to the left of the elected Labour MPs. However, reports suggest that between the poor showing in the early May local elections and the passionless effort to campaign for the Remain camp, Corbyn’s support has eroded.  Several shadow cabinet members have resigned, and reports suggest as many as 40 people from Corbyn’s team have quit.

The advantage goes to the first mover.  Who can mend their party’s fissures and offer strong leadership during a particularly challenging time?  Labour cannot force a general election.  The Tory’s secured a majority a year ago.

Technical and economic analysis use different language to talk about the same thing.  What technicians call support, an economist might see as the emergence of demand.  What a technician may call resistance and economist may identify supply.  There are numerous ways participants can anticipate supply (resistance) and demand (support).  They are often based on historical patterns of one type of another.

Sterling has not been at these levels since 1985 (see the chart below).  It is difficult to extrapolate what price will bring in supply or demand.  We must imagine that any long position that had a stop in the market was stopped out.  Of course, not all positions are protected with stops.  In addition, those who sold calls as a hedge have maxed out as the call will not trade below zero (different than interest rates).

There may be some levels that have psychological significance like $1.30 or $1.20 or even $1.00.  At $1.30, sterling would have declined by about 13% from its pre-result high.  While we thought since Cox’s murder that the Remain camp would win, we recognized that a vote to leave would send sterling sharply lower.  We anticipated a 15-20% slide in sterling.  From the $1.50 level that would target $1.2750 (15%) and $1.2000 (20%), which still seems reasonable.

Image Source: Bloomberg 

Chart

This chart shows sterling’s monthly performance since 1971, according to Bloomberg data.  There have been several powerful trends.