British Pound Rebound as Bond Yields Continue to Rise

October 2, 2021
British Pound Rebound as Bond Yields Continue to Rise October 2, 2021 Lennox Hamilton

According to a seasoned Forex market trader, the British Pound has reached a turning point and it would be foolish to dump it now. The latest developments in the United Kingdom have led Brent Donnelly, President of the Spectra Markets and author of Alpha Trader, to declare that he is no more a “bearish” forecaster on the pound, believing that the current market fear over gasoline has passed its expiration date.

As Donnelly points out, “the percentage of people who are discussing about gas station queue and faltering energy retailers in the United Kingdom is also likely to be a likely indication of a high point in the Great Energy Panic of 2021.” Donnelly, who most lately served the HSBC’s trading desk in New York, believes the Great Energy Panic will reach its apex in 2021.

“On the basis of the “climbing into an energy and labor scarcity is terrible” concept, I’ve been negative on the pound. However, I’ll point out that many attempted similar strategy in the USD at the end of last year (sell the dollar, buy bonds) and it succeeded for a few days before going drastically wrong. “ Donnelly opined.

Traders seem to have turned their backs on selling the pound, as the exchange rate between the pound and the euro dropped from a weekly top of 1.1664 to a low of 1.1548 on Wednesday before rebounding to a high of 1.1657 on Thursday. The Pound-to-Dollar exchange rate fluctuated between 1.3665 and 1.3411, before rising to a maximum of 1.3517 at the end of the trading day.
Donnelly expresses his opinion “After real rates have stabilized, money flows will be attracted to the attractive nominals. I am no longer a bear on the pound.”

What exactly are the ‘nominals’ mentioned earlier in this section? Bond yields, or nominal bond yields, are the dividend payments on UK government bonds, and they have been increasing significantly in recent months as investors expect greater UK inflationary pressure and benchmark rates at the Bank of England in the near term.

In most cases, increasing rates are supportive of a currency, thus the Pound’s decline in the face of rising yields drew the attention of investors, with one analyst – Adam Cole at RBC Capital Markets – even claiming that the Pound was now acting like an Emerging Market currency.

However, if you subtract the effect of inflation from this yield, you are stuck with the ‘real yield,’ which is the amount that owning the bond will actually give back to the holder. Various currency market analysts have argued that the issue for the pound is that although nominal rates have been rising, real yields have been stagnant or declining.

They claim that this indicates that investors are concerned about the pace of inflation in the United Kingdom, to the disadvantage of the greater yields offered by bonds. The figure below, created by Cole, Senior FX Strategist at RBC Capital Markets, illustrates the UK yield advantage relative to a 50/50 split of EU and U.S. counterparts, as well as the Pound exchange rate relative to a 50/50 split of the Euro and the Dollar.

“When compared to any G10 market, front-end yields increased, and the pound was the worst-performing G10 currency. While there was a huge one-day divergence, it is important to remember that interest rates and the pound have been going in different ways since the beginning of September, with the pound not gaining from a major expansion in rate spreads during that time” Cole opined.

However, Donnelly’s thesis is that once the UK’s ‘real’ rates have stabilized, investors will be content to return their attention to the UK’s obscene nominal yield advantage once again.

If this were to happen again, the currency’s upward prospective would seem to be very significant, as seen in the chart above. Donnelly, on the other hand, believes that real rates must stabilize before the pound can surge higher, which would need a calming of inflation expectations.

Since the recent spike in energy costs has been a clear cause of the current ‘inflation anxiety’ among international investors, it is reasonable to assume that should these inflation concerns subside, the factors will work out fine for a recovery in the pound. Donnelly believes that the energy trade – in which speculators enter the market to gamble on ever-increasing gas prices – is frothy and that a peak is near.

“The volume in UNG (the NYSE-listed natural gas fund) was over four times higher yesterday than it had been during the previous 20 days. That is very uncommon, and it has happened on the previous two times when NG reached its peak in a single day “ he explains.

According to Donnelly, “It’s a small sample size, but I think it’s worth noting because it’s rational to predict that fevered interest from tourists might recognize a blow-off lid in an average reverting market such as natural gas.” Donnelly believes that fevered interest from tourists could recognize a blow-off top in the natural gas market.

For the purposes of this article, tourists are defined as traders who join the market with the intent of making fast cash. Consumption of energy in the United Kingdom increased significantly as consumers flocked to fuel stations out of fear that there would be a scarcity of fuel. This is herd behavior, but who can criticise them given that the government’s energy cap has resulted in a considerable number of providers going bankrupt as a result of increasing wholesale prices?

As a result, consumers in the United Kingdom are likely to be the most aware of the global financial crisis and the most vulnerable to panic gasoline purchases than customers in other nations. The proportion of people speaking about gas station queues and failing energy retailers in the United Kingdom, however, is decreasing, according to Donnelly. “The proportion of people discussing about gas station queue and struggling energy retailers in the United Kingdom is also likely the prospective indication of a peak in the Great Energy Panic of 2021,” he says.

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