GBP/USD: JP Morgan is a Seller of GBPUSD
- Written by: Gary Howes
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Pound Sterling is still screening overvalued and remains vulnerable to further losses according to strategists at one of Wall Street's largest banks.
James Nelligan, an FX strategist at JP Morgan in London, says the Pound still screens as being overvalued on no less than three of his bank's models even after the near-2.0% decline witnessed in May.
Over the past three months, Pound Sterling has outperformed other G10 currencies, including the U.S. Dollar, amidst expectations for further Bank of England interest rates amidst robust UK economic activity.
However, Nelligan points out that the Bank of England's growth revisions and unexpected inflation outcomes have made the UK's central bank one of the most aggressively priced in the G10.
This positioning makes the pound susceptible to any weakening in global economic momentum. Indeed, some unwinding already appears underway as the Pound to Dollar exchange rate (GBPUSD) has retreated to 1.2322 having been as high as 1.2679 on May 10.
The losses can extend further say JP Morgan strategists, not least because recent data releases, including labour market indicators, monthly GDP figures, and manufacturing PMI data, have shown a moderation in UK data surprises.
Consequently, JP Morgan's UK economist revised growth forecasts lower last week for the first time this year.
GBPUSD meanwhile retreated on the back of official data showing that UK core inflation reached 6.8% year-on-year in April, up from 6.2% in March. Headline CPI stood at 8.7%, surpassing the anticipated reading of 8.3% and even exceeding the Bank of England's own forecast of 8.4%.
Looking at positioning data, it is observed that asset managers have largely closed their GBP shorts, which may have contributed to the recent move towards the 1.26 level.
JP Morgan's models suggest that Sterling appears richly valued on three fronts.
Based on a combination of global cyclical variables and rate spreads, fair value for GBP/USD is estimated to be around 1.20.
Analysis from JP Morgan finds this valuation is also supported by considering the relative performance of a basket of UK housing market-related equities. Additionally, when assessing global cyclical variables alone in z-score terms, GBP/USD appears overextended.
"Sterling may be expensive on these models due to its status as a reserve currency, but we would have expected EUR to be running above fair value (which it’s not) if reserve status was a strong enough theme," says Nelligan.
He attributes the risk premium above fair value partially to unwinding positions by real money investors and the relative stability of the UK banking sector compared to the US following events in March.
With banking sector risks less in focus and positioning cleaner, Nelligan expects GBP/USD to revert to fair value.
"Short GBP/USD is positive carry and can benefit from carry flow which sells G10 high beta FX such as GBP in favour of EM high yielders," says Nelligan.
