Go long on the British Pound

By Markets Covestor

Well… they did it. British voters opted to leave the European Union, and in the process sent the financial markets into a tailspin. But the biggest victim here would appear to be the British pound.

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The night of the Brexit results, the pound was down 12% versus the dollar, and while it has rebounded modestly it’s still under pressure.

There are a lot of reasons to believe this is overdone in my opinion. To start, let’s look at the numbers involved.

 

 

Some Perspective

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The day in 1992 that Soros kicked the United Kingdom out of the European exchange rate mechanism, the pound dropped about 4%. This was the infamous day that Soros “bankrupted the Bank of England,” and the impact was roughly one third of what we saw the night of the Brexit.

That doesn’t quite make sense, particularly given that the pound already freely floated vis-a-vis the euro.

Furthermore, no one has an interest in the pound “blowing up” here. While there is a lot of bad blood between the UK and the rest of Europe right now, no one wants to see the UK fall into a genuine debt or currency crisis.

 

Mutual Interests

The UK and Europe will continue to be important trading partners, and a strong UK, even out of the European Union, is good for Europe.

The United States also still considers the UK and important diplomatic and military ally, and Japan desperately wants to slow the rise of the yen. (The same can be said of the US and most countries these days.)

So if the pound sinks any further, in my opinion I would expect major coordinated central bank action from Fed, the European Central Bank and the Bank of Japan to prop up the pound. Call it a modern day version of the old “Greenspan put.”

If you believe, as I do, that the pound will not be allowed to sink too far, it makes sense to go long the pound.

 

Go Long

The easiest way to do this is to simply hold a portion of your cash balance in pounds. I’ve done that for a few clients. But if that’s not something your bank or brokerage firm offers, you can also get pound exposure via the Currency Shares British Pound Sterling Trust ETF (FXB).

Another, albeit indirect, way to play a normalizing of exchange rates would be to short the yen. No currency rose harder and faster after Brexit than the yen, which is something the export-dependent Japanese don’t want.

The yen should definitely ease when the foreign exhange market returns to “normal.” The yen has traditionally been the funding currency of the carry trade, and whenever the market goes into “risk off” mode, traders unwind their leveraged positions. That means buying back yen… hence the recent strength. So a stable pound should mean a weaker yen.

 

Export Plays

And finally, even most Brexit bears concede that Brexit isn’t necessarily the end of the world for Britain’s large multinationals, whose operations span the globe. (In fact, a weaker pound is actually better for the companies as it means their overseas earnings get translated at a higher exchange rate.)

So, even if British stocks trade sideways for several months, non-British investors would do well buying British stocks during a rally in the pound.

A decent option here, in my view, would be the iShares MSCI United Kingdom ETF (EWU). Most of the companies here are old enough to have survived the collapse of the British Empire. If they can survive that, then surely they can survive Brexit.

Photo Credit: Chris Potter via Flickr Creative Commons








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