Is the Pound the New Dollar?

In the London market last night, EUR/USD underwent the correction that we had predicted yesterday.  The euro fell amid concerns that the forex market was overextended.  But there’s another currency that has performed even better against the US dollar: the British pound.  GBP/USD seems to reach new multi-decade highs every day.  The early momentum in this pair might have been about the interest rate differential between the two countries, but that is not the driving factor anymore.  If it was, then we would have seen a correction already because of the recent dovish data.  The Bank of England is still on track to raise interest rates to 6.00% this year, but the actual decision might not be for another couple of months.

The real reason for the success of the pound is the growing popularity of British assets.  British assets are denominated in pounds, and so when foreigners want to buy British assets, they are compelled to purchase pounds on the forex market.  Just recently, the investment fund of the Dubai royal family bought a stake in HSBC Bank, and the Chinese government bought shares in Barclay’s Plc.  DailyFX.com has some great analysis on the rise of the cable.  The demand for pounds is skyrocketing, and that is the main driver of growth in GBP/USD.

This very phenomenon is the reason that the US dollar has been so stable and strong through the years despite the twin deficits (budget and trade).  The demand for US stocks, US real estate and US Treasuries never waned, and the US dollar was the prime beneficiary.  But the global environment has changed.  Iran recently asked Japan to pay for its oil in yen instead of dollars.  Six Middle Eastern countries (Saudi Arabia, Kuwait, UAE, Qatar, Bahrain and Oman) are planning to drop their dollar pegs and establish a single currency for the region.  The growing protectionism in the United States (the scrapped deals for Dubai Ports World and CNOOC) certainly does not help matters.  American real estate is not as attractive in this market with prices sinking and the bottom in danger of falling out.  And US equities are not doing as well from an international perspective due to the depreciation of the US dollar.

In the face of the shifting paradigm, the pound did hit some stumbling blocks in the forex market today.  GBP/USD declined from its 26-year high last night, falling as low as 2.0539.  But the fall was not due to changes in the currency’s fundamentals.  Rather, the losses in the US equities markets triggered a bout of risk aversion, and the carry trade unwind led many currency traders to pare back on pound holdings.  But futures traders have positioned both the US stock market and the British pound for a rebound in later trading.  The sterling is looking like the currency du jour in the forex market, and traders would be smart to go along for the ride.