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Technical indicators aside, what are the fundamentals that should support a currency’s strength? We can point to things like economic strength, political stability and high interest rates as among the basic factors. There are other influential factors, for sure, but those three are the basic fundamentals that decide whether the lines go up or down; at least, they are in normal times.
When we look back at the 2016 Brexit vote, we can see how the first two factors hit the Pound against the Dollar. The UK’s future economic strength was called into question, certainly given the forecasts surrounding Brexit. Political stability, ranging from The Troubles returning to Northern Ireland, Scottish independence and a government without a working majority also added to Sterling’s pain. As such, the “yes” vote for Brexit saw the Pound drop 10% against the Dollar, almost overnight.
In the years that followed, the Pound has been sensitive to Brexit news. Some of the earlier hysteria wore off, but GBP would normally rise when there was a sniff of a deal with the EU, and fall when no deal loomed. A case in point is during the 2019 UK General Election. When Boris Johnson’s Conservatives won an 80-seat majority, the consensus (at the time) was that the UK would have the impetus (political stability) to go for a deal. GBP got a big bump against the Dollar post-election, hitting a year high on 12th December of $1.347.
Dollar roared in early 2020
Of course, everything changed in 2020. The Dollar had a fine spring as investors looked for the ultimate safe haven. Cable plunged to multi-decade lows that made the Brexit vote shifts look positively tame. Over the summer, traders fled from the greenback as hopes of a global economic recovery rose. By September, GBP had recaptured a position close to those post-election highs of 2019.
Then October and November came around, and predicting (politically) moves in Cable became as random as guessing numbers with Keno. A case in point: Boris Johnson’s speech on 16th October where he told British business to prepare for “no-deal”, and claimed the “trade talks were over”. After a brief dip, the Pound actually rose significantly against the Dollar after that speech. Traders believed, correctly, that Johnson was calling the EU’s bluff, but it nevertheless took a huge leap of faith to predict he was doing so.
Huge volatility over election night
And, as we approached the US election, the Dollar continued to decline. One reason cited was the presumption that a Democrat clean sweep of Congress and the White House would lead to an agreement on the much-awaited stimulus package. As such, risk appetite was back on, and currencies like the Pound gained. Indeed, the Pound even made big gains against the Dollar a day after Boris Johnson announced England would go into lockdown for a month. Remember what we said about fundamentals? The consensus view is that it will take a big chunk out of the UK’s economic recovery, but that did not deter Sterling buyers.
The Pound continued to rise up until the eleventh hour of the US Presidential election. Traders viewed a Biden win – and that stimulus package – as a given, and thus risk appetite abounded. It seems to not have occurred to many that, if he were to achieve victory, he would not be inaugurated until January. Why such a consensus that a lame-duck Congress and President would agree on a stimulus package?
Of course, as many forex traders will have noticed, the Pound dropped considerably (over 1% to $1.29) against the Dollar as the results poured in, and it became increasingly clear that Joe Biden was not going to have the ‘clean’ victory he desired. When the morning hit, and it looked like Biden might squeak home, the Pound regained much of those losses to move back over the $1.30 mark.
The point of all this is that much of these winds will still continue to blow against Cable. The US election did not feel like a cathartic moment for American politics; Brexit is certainly still not sorted, and no deal remains a possibility; negative interest rates remain on the table for the Bank of England; and, there are also the economic problems caused by the latest lockdown. Most forex specialists believe that there will be strength in a buoyant Pound to come against a weakening Dollar. But given what we have seen, it would be no surprise if they missed the mark.
