Time Up for Pound Sterling's Stellar Run against the Euro and Dollar says Crédit Agricole

- GBP's strong run could be over
- GBP said to be overvalued
- Positive U.S. data this week is a key risk to GBP

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The British Pound starts the new week materially lower than where it was at the half-way mark of the previous week thanks to an aggressive sell-off on Thursday and Friday, and one analyst we follow says the currency has now peaked.

"Many positives are in the price of the overvalued and overbought GBP in our view," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

The Pound fell amidst a wide decline in stock markets and commodity prices, confirming the currency to be highly sensitive to investor sentiment.

Therefore trade in Sterling over coming days could well depend on how the broader market landscape performs.

The big theme at present for investors is the rise in yields paid on government bonds, particularly those of a long duration. This rise in yields comes as investors dump these bonds, fearing higher inflation in the future which would materially eat into their investments.

However, what is curious is that the rise in bond yields actually reflects expectations for economic growth ahead, which would typically be expected to support stock markets and other 'risk on' assets, of which the Pound is now considered.

Therefore, good news out of the U.S. economy could well be bad news for markets and Sterling in this counterintuitive world. This is because investors are betting that good economic data means the Federal Reserve will ultimately have to withdraw the generous stimulus that has fuelled markets higher.

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If this week’s U.S. ISMs and non-farm payrolls surprise on the upside and continue this theme, the Dollar could well find itself supported this week says Marinov.

By contrast, Marinov eyes the Pound and Australian Dollar as the two most at-risk currencies should strong economic data trigger another rise in the value of U.S. yields.

"Persistently higher UST yields can also start weighing on risk-correlated and commodity currencies vs the USD. Our recent sensitivity analysis highlights that the AUD and the GBP could be the most vulnerable to a potential combined spike in UST yields and risk aversion," says Marinov.

Turning to the Pound's stellar 2021 rally which made it the best G10 performer of the year until the end-week selloff, researchers at Crédit Agricole say the gains are now in and a weaker profile is likely.

"Many positives are in the price of the overvalued and overbought GBP in our view," says Marinov. "The GBP has little else to offer beyond its apparent vaccine advantage."

Modelling by Crédit Agricole suggests that the Pound Sterling comes in last in a ranking of FX fundamentals due to the UK’s inferior economic productivity, current account deficit, recent stock market performance, low real yields and extreme lockdown severity.

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Analysis also shows the Pound is starting to look overvalued, when using both short-term and long-term valuation models.

Analysts at HSBC last week told client the Pound is trading well above levels justified by fundamental factors that should mean it is anchored lower.

"GBP’s reach exceeds its grasp," says Dominic Bunning, a strategist at HSBC in a recent briefing on the currency. "In our view that upward momentum is undeserved from a value perspective. The move in GBP has far exceeded that of other anchors which one would normally associate with currency outperformance."

The market has also apparently crowded the bet for further Sterling upside as positioning analysis at Crédit Agricole suggests the market has already established considerable 'GBP longs'.

The implication of a crowded trade is that it requires ever more new entrants from a dwindling field of candidates to keep the move going. Any turn in direction could also see investors book profits and bail out of the position, triggering a sharp reversal.

However, Crédit Agricole note that while speculative accounts have been driving the currency rally, "corporates still seem to
be relatively underweight the GBP and thus could offer some support".

According to Marinov Risks to Sterling's three- to six-month outlook include:

1) the UK vaccine advantage could disappear as soon as Q2 as more countries embark on vaccine rollouts;
2) the BoE can try to push against further tightening of the UK financial conditions;
3) the UK economic rebound in H2 could be hampered by a weak domestic demand on the back of surging unemployment and business
spending, curbed by post-Brexit uncertainty and the risk of Indyref 2.0 in Scotland.

Credit Agricole upgraded their forecast for the Pound earlier in February but are conscious that much good news is already in the price.

Any further upside in the Pound could therefore only arrive in the second half of 2021.

The Pound-to-Dollar exchange rate is forecast at 1.37 by the end of June, 1.38 by the end of September and 1.39 by year-end.

The Pound-to-Euro exchange rate is forecast at 1.1364 by the end of June, a level expected to persist for the duration of 2021.