Stanley Druckenmiller's Bullish Case For The United Kingdom And The Pound
Stanley Druckenmiller recently commented in a Bloomberg interview that he believes there is a bullish case to be made for the UK.
With the pro-business, pro-Brexit Conservative party securing a landslide victory in the UK's 2019 general election, the pound could see further upside with reduced political uncertainty.
Reduced political uncertainty could lend to both increased domestic business confidence and investment, and also (perhaps more importantly) increased foreign capital flows.
Foreign capital flows into UK assets, as the "political risk premium" continues to unwind, could provide long-term support for the pound.
As traders still appear to remain net-short (based on CFTC data), and given that we are still quite far away from the 2018 highs for GBP/USD (above 1.40), a strong bullish case can still be made for the pound going forward.
(Source: Twitter; excerpt taken from Bloomberg, December 2019)
Stanley Druckenmiller's thesis is simple: Boris Johnson is viewed as a smart, pro-business leader, also recently having won a strong majority for the Conservative party in the UK's recent general election of 2019. In addition, Druckenmiller comments that the United Kingdom's growth is less reliant on public spending (an important component of aggregate demand), and has a healthier debt-to-GDP ratio, and less expensive financial assets.
UK risk assets such as equities are likely still under-priced given the "political risk premium" (conceptually speaking) that has been priced into these assets ever since 2016 when Brexit was announced. The greater and more prolonged the political uncertainty surrounding Brexit, the greater the likely discount is that has been priced into UK assets. As this "risk premium" unwinds (or continues to unwind), the better UK assets are likely to out-perform.
The recent drop in the pound, following the immediate rise after the pro-Conservative general election result, is likely overdone at this stage. As BBC News outlines, there is a possibility that the UK is able to start a new relationship with the EU as soon as January 2021.
While the risk remains that the UK exits the European Union without a trade deal in January 2021, it is not only in Boris Johnson's clear interest to secure a deal (his campaign slogan was "Get Brexit Done"), but from an international perspective it is in the Europeans' interests to also "play ball". A deal would likely strengthen the pound significantly, which would make European exports cheaper and UK imports relatively more expensive in euro terms. In other words, by getting a deal done, Europe could benefit on a foreign exchange basis.
In addition to the potential foreign exchange benefit, having strong business relations with the United Kingdom going forward would help to reduce business uncertainty all over Europe (the uncertainty is not limited to the United Kingdom). At a time when Germany and France are returning year-over-year GDP growth rates of 0.1% and 0.3%, respectively (in the third quarter of 2019), clearly the eurozone could do with all the 'FX benefits' and business confidence it can find.
Overall, then, the case for a bullish pound is likely to remain intact. That means that the GBP/USD and EUR/GBP pairs are likely to remain bullish and bearish, respectively. While, as shown in the table below, the United Kingdom's short-term central bank rate (as set by the Bank of England) is only +0.75% (not as great as that of the United States or Canada, for instance), it is still safely positive (and well above the European Central Bank's -0.50% deposit facility rate).
An influx of capital into the United Kingdom, and/or increased domestic business investment, could help unlock inflationary potential in the economy. The potential for this would probably have been a factor in the Bank of England's recent decision to keep rates at +0.75%. If growth and inflation do both pick up, the Bank of England could even raise rates.
As interest rates of countries tend to support their currencies (due to the higher yield), this could support the pound even further. Note that even amidst the uncertainty in mid-2018, the GBP/USD pair was trading at well over 1.40.
The weekly candlestick chart above for GBP/USD, created by the author in TradingView, shows the peak of GBP/USD in April 2018 of approximately 1.44. The shaded area shows the long-term trading range since the currency pair's lows in late 2016 after the announcement of the decision to "Brexit". With Brexit potentially now coming closer to closure, there is a strong case to be made for the pound to at least find its way back to the 2018 high.
An influx of capital and investment would support the demand for pounds for many months to come. It is unlikely that the political risk that has been priced into the pound to date will become even dearer than it has thus far, and therefore it is probably unlikely that we see the lows of under 1.20 any time soon. We will most likely see 1.40 next for GBP/USD, not 1.20. And even without smooth-sailing negotiations with Europe, Trump and Boris have already begun to build positive relations; the United Kingdom seems to have a lot going for it, if Boris can live up to even half the optimism he has shown.
Indeed, this is not all about hard data, but sentiment. Capital flows to economies that provide not just opportunity, but political stability. Now that the Conservative party has a strong majority, and a clear intent to "do deals" (and get Brexit done...), the stage has been set for the pound to rise over a multi-month time frame.
Also, as alluded to previously, it is probably unlikely that the Bank of England lowers rates any time soon, due to the risk of business conditions heating up as perceived uncertainty is reduced and general sentiment improves. Rates are, all considered, likely to remain on hold for now at +0.75%.
The updated weekly candlestick chart below shows the UK one-year government bond yield set against the far-right y-axis (red line), which is being priced at only 0.617%. Further upside of over 10 basis points (in line with the central bank rate of +0.75%) might be enough to get the GBP/USD back up over the midpoint of its current trading range (yields tend to correlate positively and strongly with spot prices of currencies).
In short, this author supports Druckenmiller's sentiment on the United Kingdom, and by virtue of that the pound sterling. We can also see from the chart below (from Investing.com) that weekly Commodity Futures Trading Commission's (CFTC) data shows that GBP speculative positioning is still net-short among Sterling traders. A further unwinding of these short positions could send the pound higher in the near term (although we should not be surprised to witness volatility on both sides in the near term).
If you are short the pound, you may wish to reconsider your position over a longer time frame. The 'upside risk' would appear to be quite convex at this juncture; GBP/USD prices above 1.40 still remain in sight. I first identified this in September 2019 (article), and the 'bullish' case appears to remain as strong as ever.