IB FX View

Britain thrown to the pigs

Thursday May 21, 2009

The British pound is recovering from an earlier belly-ache brought on by the specter of a loss of its AAA credit rating. According to Standard & Poor’s, there is a one-in-three chance that the government’s incessant spending to stave off recession will end in a loss of its ranking. In that case it would be the fifth west European nation to lose its crown and would join the so-called PIGS of Europe – Portugal, Ireland, Greece and Spain. The pound fell to $1.5515 at its weakest point today after a New York close of $1.5753. By 10:00am in New York today the pound has recovered to back above $1.5700.

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Britain is singled out as a basket case by the ratings agency on account of its rising debt burden, which is reaching 100% and the agency thinks that this might be more like a medium term event than anything else. The jolt today sent stocks in London down alongside the price of British gilts as well as the cost of insuring against gilt defaults.

S&P announced a reduced outlook on Britain moving its outlook from ‘stable’ to ‘negative.’ While four nations have already been stripped of AAA status, it’s probably a simple function of the recession and to not reflect the deterioration in public finances across the western world would likely make a mockery of the already-tarnished ratings agencies. The industry has in the past been criticized for moving too little, too late to reflect weakening fundamentals at companies.

In this case, the position is clear. The failure of the entire financial system across the western world has created a need for public money to rescue and support ailing institutions to stave off larger problems. The resulting stability comes at an onerous public cost. To not reflect this would be unreasonable. The danger for Britain and the pound is whether other nations suffer the same fate. If the buck stops with Britain there will ultimately be severe repercussions on the government’s ability to fund a swelling deficit and on the flow of investment capital into the country. Neither case looks positive for the pound, which fell right across the board today.

The flight out of sterling today was accompanied by an increase in appetite for dollars following a trifecta of events. Wednesday’s FOMC minutes poured cold water on recovery theories with the Fed wondering publicly about the longevity of the recovery. Yesterday former Fed chairman, Alan Greenspan speaking at a BipartisanPolicyCenter meeting in Washington to address questions on the financial sector declared his lack of confidence that the rebound would hold.

Anyone who has ever read Mr. Greenspan’s autobiography, penned just in time to greet the financial crisis some people like to accredit him with creating, will understand his passion for statistics. Mr. Greenspan’s observation that the number of single-family homes falling into default does not signal an end to the price declines. In reference to those liquidations he said, “I don’t think we’re there yet” noting that without a leveling off in house prices a mortgage crisis remains a clear and present danger.

Finally, jobless claims in the U.S. continued to rise this week with the total number of insurance claims now running at a pace of 6.66 million. This marks the sixteenth consecutive week of rising claims and as such the data is deviating from the traditional script, which argues that after a peak in weekly jobless claims, the worst is over. However, many people are coming around to what central banks keep telling us, which is that this recovery is likely to be a tepid one. Today’s data certainly argues that point and provides a shot in the arm to the view that recovery will be far from robust.

We noted at this time last week that the boost to jobless claims from the Chrylser filing was not an aberration, which some were quick to take solace from. The fact is that the recession is costing far more than any recession that has gone before and in this case has toppled not just one, but more likely two of the nation’s automakers. GM has another week to file for Chapter 11 and most likely will. It says it plans to idle 36 plants, throughout the filing process, which could see them closed for nine weeks. That will create another boost to jobless claims that cannot and should not be ignored.

The major question for us going forward in terms of the dollar is whether the false start for recovery bulls will be reflected in a similar false start for dollar bears. The euro, which today buys $1.3750 is starting to look heavy and today’s story that the ECB mulled purchases of twice the size that it recently announced when it eased interest rates, won’t do the euro one single jot of good. Already the potential for loss of Britain’s credit rating and the current ‘good’ standing of the Eurozone’s fiscal position relative to what it could be if it dug deeper to bail out its system, has seen dramatic credit spread shifts with investors favoring German debt over anything else. The euro is heading for safe-haven status by virtue of what it has not done because the ECB feels as though it can get away without it.

But with stock markets at a potential tipping point and investor confidence stating to wear thin, the onus will be on the euro bulls to defend their perspective against the background of a weaker economy rather than a recovering one.

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

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