Top currency trading banks are just as flummoxed by sterling’s prospects next year as investors who are opting to stay out of trading until further details emerge about the path the UK is likely to take in its divorce from the EU.
With plausible outcomes still ranging from no Brexit at all to a chaotic exit without a deal, banks’ number crunchers are forced to produce a number of event-contingent estimates of where sterling is likely to trade in the next 12 months, rather than just coming up with one number to guide companies and investors.
Analysts suggest that depending on how UK politicians manage the divorce process from here, sterling could soar to $1.59 or plunge to $1.10 — a headache for those more accustomed to generating precise guidance.
“Forecasts and trades remain highly conditional and tactical,” noted Paul Meggyesi, managing director in JPMorgan’s global currency strategy team.
The most likely outcome for Mr Meggyesi is an orderly Brexit, which he believes will cause sterling to appreciate some 5 per cent against both the euro and the dollar. However, the pound could be at least 10 per cent lower against its peers in the case of a no-deal Brexit.
“The probability of no Brexit and no deal is 20 per cent apiece. Sterling upside in the former is around 10 per cent, downside in the latter at least 10 per cent with a high probability of an undershoot,” Mr Meggyesi said.
Analysts at banks generally predict the exchange rate levels of major currencies on a quarterly basis, taking into account a range of indicators such as economic data and political factors.
Companies use those forecasts for planning and budgeting for the years and quarters ahead, baking in expected currency levels into their forward looking estimates for profits and costs.
But while analysts’ expectations should provide companies with some visibility into what lies ahead, fears around Brexit have pushed dealers to hedge their bets in predicting sterling’s path in 2019.
In an extreme example, BNP Paribas’ sterling forecast now includes five different scenarios, each with a different level for the pound against both the dollar and the euro. The estimates range from $1.36 against the dollar in the case of a second referendum to $1.15 in the event of a no deal.
The pound is widely believed to be cheap at current levels so, in theory, it offers good value for long-term investors to buy it, says Bank of America Merrill Lynch, whose analysts believe the currency to be 15-20 per cent undervalued.
But few buyers are biting, as the many possible scenarios and their associated sterling reactions created by Brexit are hard to quantify.
One of the most optimistic forecasts on the pound comes from Japanese bank Nomura, which expects the pound to finish 2019 at $1.59 against the dollar.
“A large part of our upbeat sterling forecast is that we are very bearish on the dollar,” said Bilal Hafeez, head of European fixed income research at Nomura in London. “Our base case is that the UK will avoid a hard Brexit and either a deal is agreed before the deadline or a second referendum takes place.”
HSBC, meanwhile, has essentially given up trying to predict the politics. Its forecasts pencil in the pound trading consistently around $1.30 throughout the year — a view it stands ready to adjust when clarity emerges on the terms of the Brexit deal.
If a deal is passed in the UK parliament, sterling could rise to $1.45 against the dollar in 2019, the bank said. However, in the event of a no-deal Brexit, HSBC sees sterling trading at near parity with the euro and at $1.10 against the dollar.
Even without Brexit, forecasters often get their predictions wrong. Going into this year many analysts expected the dollar to continue trading at weak levels in a continuation of the trend that started in 2017. This assumption held until mid-April, when the pound traded at close to $1.44, its high for the year against the US currency.
Since then, the dollar has picked up, powering higher against both major and emerging markets currencies and helping to push the pound lower to about $1.26. Analysts are yet again taking divergent views on the dollar’s path in 2019, but with the added difficulty of Brexit further muddying the waters.
Barclays believes that currencies markets are “experiencing a temporary reprieve from reality” as the assumption seems to be that the Federal Reserve is near the end of its tightening cycle as the US economy runs out of steam.
While the negative narrative around the US persists, emerging markets and a few select major currencies could benefit, said Marvin Barth, head of currencies strategy at Barclays. This is unlikely to last into 2019, according to Mr Barth, who expects the dollar to move higher against major peers such as the euro and sterling.
“Our forecasts are in the top of the range for the dollar, which means our euro and sterling views are at the lower end of expectations across the street,” Mr Barth said.
“We think that within the G10 universe the dollar will continue to be relatively strong and that the pound will remain somewhat weak, primarily because of the UK economy,” he added.
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