London - Sterling might rally to a three-year high of $1.55 if a cliff-edge Brexit is avoided by the United Kingdom, Stephen Jen, co-chief investment officer of Eurizon SLJ Capital, a London-based hedge fund said on Wednesday.
With a lot of short positions rife in currency markets due to a rush by investors and corporate treasurers to hedge against Brexit risks, the British pound is one of the most undervalued currencies among its developed market peers, Jen told the Reuters Investment Outlook Summit.
“Sterling is going up,” Jen, who previously held roles in Morgan Stanley and Bluegold Capital, said.
“Assuming no changes, we’re talking about $1.55 against the dollar as we are way undervalued....There’s a lot of embedded sterling shorts that will be lifted as sterling recovers.”
Prime Minister Theresa May is trying to convince her ministers to accept a draft European Union divorce deal but it has so far been denounced by both Brexit supporters and opponents.
Sterling has weakened about 10 percent from a 2018 high of $1.4377 thanks to concerns about Brexit negotiations and a resurgent dollar, though it has bounced off this year’s low of $1.2662 hit in August as hopes of a deal has grown.
Some dollar weakness might help. Jen reckons however that while the dollar is in overvalued territory, it could rise more in the short term.
“I think we’re going to see an inactive ECB for much of next year versus an active Fed,” he said, adding even if the European Central Bank were to raise interest rates, they would remain in negative territory.
“And this will mean a modestly lower euro,” Jen said, adding the single currency was likely entering a $1.05-1.13 range.
Currently, money markets are pricing a euro zone rate rise in December 2019 but stuttering growth and Italy’s crisis are starting to cast doubt on this.
That could fire up the greenback even more, said Jen who sees dollar cash as the best asset to hold for now, given it has broadly outperformed equities as well as bonds so far in 2018.
Looking to China, Jen saw it likely Beijing would adopt a more conciliatory approach with the United States.
With China reeling from falling equity markets and trade tariffs, the yuan has weakened against the dollar this year and is perilously close to falling below the psychologically key 7-per-dollar mark.
“Yes, it will happen, it will go through 7/dollar,” Jen said, though he saw it unlikely to weaken much beyond that.
“They will fight to stabilize it.”
Jen added for 2019:
** The three big threats for global markets were U.S. inflation, lofty asset market valuation and protectionism
** Emerging currencies cheap but “herd-driven” move against the yuan could cause “period of discomfort” for asset class
Follow Reuters Summits on Twitter @Reuters_Summits
Additional reporting by Ritvik Carvalho; editing by Sujata Rao and Marie-Louise Gumuchian