Analysts have predicted a renewed slump for sterling against the dollar as the US gears up to raise interest rates for the first time in almost a decade, creating a new test for UK equity managers.
Though it remains strong against other currencies, the pound has fallen almost 4 per cent against the dollar since late August, with much of the move coming this month.
The drop has been driven by cautious sentiment from the Bank of England on the one hand and, on the other, the belief that a rate hike by the US Federal Reserve in December is now a near-certainty.
The pound is currently worth $1.52, having fallen earlier this month when Mark Carney advised a domestic rate hike was not on the horizon. Capital Economics has predicted that diverging monetary policy would push sterling down to $1.40 by the end of 2016 – posing problems for parts of the UK equity market in the process.
“All else [being] equal, [our prediction] would boost the value in sterling of the earnings of UK multinationals’ affiliates in the US and erode the dollar value of the earnings of US multinationals’ affiliates in the UK,” assistant economist Andrew Hunter said.
The attraction of so-called “dollar-earners” for UK equity managers is complicated, however, by the fact that some of the most high profile can be found in the resources sectors, which face their own headwinds due to falling commodity prices.
As well as seeking UK-listed companies with dollar earnings, some UK managers have sought to make use of their ability to put up to 20 per cent of their fund in stocks listed elsewhere.
One is Steven Bailey, co-manager of the Liontrust UK Macro Growth and Macro Equity Income funds. He said: “The Fed will be first to tighten so there will be further dollar strength and then some sterling weakness.”
Mr Bailey said pharmaceuticals such as GlaxoSmithKline and AstraZeneca, both of which derive a sizeable proportion of their revenues from the US, could benefit. The manager said he was also maintaining his significant overseas weighting.
A relatively small proportion of UK managers have taken advantage of this method, however: 19 per cent of active funds in the IA UK All Companies sector have more than 10 per cent of their assets under management in non-UK stocks, according to research from JPMorgan Asset Management.
This is despite an increased number of research houses predicting ill for sterling. Analysts at Deutsche Bank have placed a $1.44 price target on the pound as a result of anticipated monetary policy divergence. This would represent the lowest level for sterling since the financial crisis: the currency reached $1.37 in early 2009 but has subsequently remained above $1.445.
Its view was reinforced last week by UK unemployment data, which revealed wage growth had again missed expectations in September.
The bank said in a note to clients: “One of the main risks to our bearish sterling call last week was a reacceleration of wage pressures forcing the BoE into a more hawkish stance in the first half of next year. So far, the precise opposite seems to be happening.”
Mr Bailey at Liontrust predicts a number of other factors could also weigh on the currency, such as weaker oil prices, the UK’s persistent budget deficit, and the referendum on EU membership.
“As we get closer to [the referendum] we expect to see a further weakening of sterling. When we had the vote on Scotland [in September 2014] sterling had been strong all year, but in worries over the vote sterling sold off quite significantly,” he said.
Will the UK follow its US compatriots?
As investors become more confident than ever in the likelihood of US rates rising imminently, attention has focused on the UK’s willingness to follow suit.
Andy Haldane, chief economist at the Bank of England, struck a cautious note on November 13 when he warned the BoE would not be obliged to follow its US counterpart.
If the Fed does hike in December 16, attention would turn to whether it would raise rates again before the Bank of England makes its first move.
TwentyFour Asset Management chief executive Mark Holman said at last week’s Chelsea Financial Services dinner that this scenario, though unlikely, would have a significant impact on sterling because it would erase its “positive carry” against the dollar.
This is because the US Federal Funds rate, currently set at between zero and 0.25 per cent, would then be materially higher than the 0.5 per cent UK base rate.
