The UK is tightening fiscal policy while the CB is enacting QE. The market thinks that this will substantially weaken the pound, is that the correct logic

no. but drives short term portfolio shifting and specs

or is QE not real money printing and the tight fiscal is the real force to be reckoned with?

yes. but takes longer to bite.

I’m just wondering if the mkt is getting positioned the wrong way based on faulty logic. Any thoughts?

totally agreed! the trick is timing and vs what currency.

the euro has it’s own set of deflationary forces already in place.

the dollar looks over sold against something based on wrong way qe betting.

the pound selling has to be against something.

the only currency left is the yen, which may be where the flight to safety is going. Shorting the yen has also been the widow maker- more reason to believe it’s over bought.

And their trade flows aren’t so positive any more, and they have been sporadically selling it probably vs the dollar, adding to supply. And the prospects of meaningful fiscal tightening in Japan seem less than the UK, euro zone, or even the US.

so the home run may be the yen against the pound.

the other flight to quality currencies have been the commodity currencies which could correct substantially. The $A looks particularly over valued based on anecdotal purchasing power parity. a diet coke is $3 for example, but they are China’s coal mine.

again, it will be about timing.

if the pound does start firming against the yen fundamentally, which it should, it can go for a long time, so it’s probably not worth trying to call the exact bottom.

6 Responses

  1. Actually the gbp/usd forward basis has gone bid, sharply so since Osborne introduced his austerity budget. Implicit is that in the future it will be harder to raise pounds from dollars, spot weakness in the gbp notwithstanding. We saw the same dynamic in the eur last spring, where the forward mkts correctly anticipated a coming scarcity of Euros (relative to usd) due to austerity and a mildly tighter ECB (ltro expiry), even though the commentariat at the time was only focusing on Greece et al.

      1. Perhaps, though my suspicion is largely driven by the dynamic you describe below: unit availability. The fwds have gone bid in chf and other crosses too. So it looks like it’s really more of a $-driven theme with deficits here still on a war footing while other countries retrench.

  2. Why do you assume that fiscal expansion has a weakening effect on the currency? True, aggregate money supply will not increase to the sam extent but opposite to that the economy will remain depressed longer offering lower returns on capital on the margin. Isn’t this the empirical lesson we learned from the Reagan years, ie. that strong fiscal expansion “financed” or matched by bond sales lead to higher interest rates and a strong currency?

    1. higher deficits make units of the currency easier to get. actual economic expansion usually reduces the deficit via ‘automatic’ fiscal stabilizers, making the currency harder to get.

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