"The future will be better tomorrow."
-Dan Quayle
Tomorrow will not be better for the UK, according to Jim Rogers,
Chairman of Rogers Holdings and co-founder of the Quantum Fund.
Seventeen years after he and George Soros engineered an attack on
the pound, Mr. Rogers says the currency will fall further against
both the dollar and the euro, because "...It's simple, the UK has
nothing to sell". In his opinion, the pound had two pillars of
support - North Sea oil and its banking sector. Now oil is running
out, banks are imploding, London is losing its relevance as a
financial sector and UK housing is in worse shape than in the U.S.
He is not alone. Several press stories have referred to London
recently as "Reykjavik-on-Thames", drawing parallels to Iceland's
debt-burdened economy, failing banking system and plunging
currency. Markets appear to agree; the pound slid to its lowest
level since 1985 against the dollar last week and is threatening to
revisit recent all-time lows against the euro just above .9800. At
one point last Friday, it touched a low of 1.3503, down over nine
percent from its weekly highs against the dollar and over five
percent against the euro. Over the past year, it has fallen by
around 30 percent against the dollar and over 25 percent against
the euro (view a 2-year chart by
clicking here).
There is a lot to be gloomy about. On Friday, it was reported that
Q4 GDP fell by 1.5 percent, more than most estimates and the worst
quarterly decline since 1980. With two negative GDP prints, the
economy is now "officially" in recession and is expected to shrink
by an additional 2.5 to three percent in 2009, higher than current
estimates for the U.S. and Europe. The fiscal deficit is mounting
as tax receipts fall and benefits rise, with forecasts calling for
the 2009 deficit to equal almost 10 percent of GDP, compared to 5
percent for the Eurozone and around 8 percent for the U.S.
Similarly, public debt is expected to increase rapidly, as is the
case for the US and other countries. Household debt as a percentage
of disposable income soared to 177 percent in 2007, much higher
than even the U.S. and as consumers attempt to rebuild savings,
consumption is expected to fall sharply. The weak pound will only
exacerbate that trend, as soaring import prices curb demand even
more.
The banking sector is in a tailspin. RBS warned that 2008 losses
could approach $40 billion and there is a fear that full
nationalization might soon become necessary for them and other
major banks. The government announced a bailout package last week
that provides additional liquidity to the system, insurance against
future credit losses and extends various types of guarantees. It
also established a new Asset Purchase Facility (APF) for the Bank
of England (BOE) to purchase high quality assets such as CGS paper,
corporate bonds, syndicated loans and commercial paper. While this
will initially be funded by bill issuance, and hence, will not
increase money supply, the wording leaves the door open for
unsterilized purchases, or quantitative easing. The BOE is expected
to cut rates by 0.5 percent to one percent on February 5. The
market is pricing in further cuts to 0.5 percent, but a move to
quantitative easing would imply close to zero percent short-term
rates as is the case in the U.S. and would exert further downward
pressure on the currency.
The yield curve has predictably steepened. At the end of last week,
two-year note yields fell by 0.14 percent on the week to 1.45
percent, while ten-year gilt yields rose by 0.40 percent to 3.69
percent, taking the spread to 2.24 percent, the widest since at
least 1992. Speculation about the ratings agencies considering a
downgrade of the UK's AAA-rating is premature, but it is exerting
pressure on long-term yields and on the currency.
The UK economy will struggle terribly this year, but so will most
other economies. Further weakness in the currency is almost
inevitable in the near term, but is not necessarily a negative,
unless it scares away overseas investors from the bond market.
There is no evidence yet of that happening and no auctions have
failed, but it bears watching. A weaker currency will help correct
the trade deficit by curbing imports and boosting exports and will
force additional savings. The only real negative would be from
rising inflation, but that is not currently a concern for any major
economy and probably will not be until 2010 at the earliest.
The pound fell as low as 1.05 in 1985. I don't see that happening
again, but certainly a move towards 1.25 against the dollar and
parity against the euro is possible over the next few months. In
2010, assuming we see some form of global economic recovery, the
pound ought to rebound back to historically stable levels around
.70-.75 against the euro and perhaps 1.60 against the dollar.
Looking Ahead
The dollar continues to rally vs. the euro, GBP and most other
major currencies except the JPY. In my opinion, the rally is based
on several factors:
- Heightened risk aversion as a result of financial turmoil and
shaky stock markets: This should continue to benefit the dollar,
but it is a temporary phenomenon
- Pessimism about economic growth in the UK and Europe: This is
completely justified and those currencies could fall further in the
near-term.
- Heightened expectations about a quicker than expected recovery
at home as the Obama administration takes over: This was to be
expected, but in my opinion will meet with disappointment this
spring, as markets reflect the reality that more stimulus is needed
and the recovery will take longer than anticipated.
- Emerging market currencies continue to struggle as equity
related outflows continue: While I am more optimistic about their
longer-term fate, they too could lose additional ground in the near
term.
I have lowered my expectations for the GBP and EUR based on current
and projected economic weakness, but remain convinced that the
dollar will fall later this year and into 2010 against the
commodity currencies and stronger emerging market currencies. Until
then, the JPY and CHF will continue to shine, but should lose their
allure along with the dollar when the global economy shows signs of
regaining some stability.