Morning Commentary: Myth vs. Reality

Foreign Exchange - Morning Commentary
Myth vs. Reality
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The UK will officially exit the EU at 3 pm PST this afternoon.  While this makes a nice headline, the reality is that the UK is just leaving in name only as it will enter into a transition period that keeps the UK-EU relationship unchanged through 2020 as the two sides negotiate a trade deal.

Looking forward, the question is, what happens to the GBP?  Due to Brexit uncertainty, the pound has fallen sharply due to a variety of factors including a pullback in foreign inflows.  Case in point, net foreign direct investment (which helps funds the UK current account deficit) practically came to a stop ahead of the general election. 

As a result of the slowdown in foreign investments, UK assets are both under owned and undervalued.  With near term Brexit uncertainty removed, some believe that investors would rebalance their portfolios to add underweight UK assets and lead to GBP strength as the currency converges to long term valuation levels.  To us, this appears a bit premature. 

One way or another, Brexit will fundamentally reshape the UK economy as the UK’s relationship with it largest trading partner gets redefined.  It stands to reason then that any structural change to the relationship should also change the GBP’s relationship with long term valuation measures, undermining the argument that the GBP is cheap relative to its average since 2016. 
  • The World Health Organization has declared the coronavirus outbreak a global health emergency.  This declaration led to a bit of optimism as the WHO will “coordinate the response to a disease that has caused widespread concern and confusion.”  Given this, the outbreak is still expected to get worse as illustrated by the UK reporting its first case overnight.  While Chinese equity markets will reopen Monday and should sell off sharply, nearly two-thirds of the Chinese economy will remain closed next week.  
  • China’s manufacturing PMI met expectations at 50.0 and non-manufacturing PMI beat expectations at 54.1.  However, this print doesn’t include the coronavirus impact due to the timing of the survey.     
  • European data came in softer than expected with GDP misses at the Euro area level and individual country level in Italy and France.  Euro area CPI came in mixed but was skewed to the downside, and German retail sales data also disappointed.   
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