Shorting the Pound: Fundamental analysis of the UK and Australian economies
The pandemic will act as a differentiator between economies and the Australian dollar is likely to appreciate against a falling pound because of that.
By Adi Mishra
5th January 2021, 13:00 GMT
At 8.00 last night (Monday 4th January) UK Prime Minister Boris Johnson put the UK into its third national lockdown, spelling more trouble for the already damaged economy. The UK is registering close to 60,000 daily cases, and while a herd immunity is on the horizon with the UK being the first country to roll the vaccine out, there is still a long way to go. The UK is likely to be in lockdown till at least the middle of February.
This means that businesses, having already suffered the economic consequences of 2 lockdowns and a tier system, will face further financial deterioration. The UK's growth prospects look bleak going into 2021, with Brexit difficulties looking to threaten chances of a strong bounce-back recovery. IHS Markit PMI for UK manufacturing came in at 57.5 last night, which is a very good number. However, Markit explained that this was due to 'Brexit Buying' with UK and European firms bringing forward orders, and stockpiling. This means that demand will not be so great going into this new year.
With growth prospects looking bleak, and another lockdown, UK Finance Minister Rishi Sunak will look to more fiscal stimulus, while the Bank of England may have to look to increasing the money supply as well. With more stimulus, and increase in money holdings across the economy, it is likely we will see interest rates drop or stay low in 2021(bond yields will probably drop).
Interest rate effect
Additional money supply and low-interest rates may increase inflation, which will lead to a depreciation in sterling.
With low yields due to increased stimulus in the UK, investors will look to move their money abroad in search of higher yields, and better growth prospects. This outflow from the UK will likely cause some depreciation in the value of the pound.
The UK already has a lot of debt, debt to GDP is at about 100%. Australia on the other hand has lower levels of debt, net debt will remain less than 50% of GDP. This means that Australia will not be constrained by their debt levels to reduce government spending in order to make interest payments. However, the UK will eventually have to do this, in order to 'balance the books'.
In the shorter term, Australia's economy is and will continue to recover well, with daily Covid-19 cases at only 21, and manufacturing PMI holding close to 3-year highs at 55.7 currently. Australia, therefore, has better growth prospects.
Australia may be in a better position for trade as well, as China is Australia's largest trading partner and the Chinese economy looks to be growing well. Manufacturing PMI is at 53, suggesting that Chinese demand for Australian commodities will be strong.
Australia looks in a strong economic position, and money will likely flow into Australia, therefore it is likely that the AUD will appreciate.
I will therefore be shorting the Pound against the Aussie dollar if I can find the right technical entry.