PA ANALYSIS: Sterling 'flash crash' sign of things to come?

Added 7th October 2016

The pound has collapsed under the pressure of aggressive post-Brexit rhetoric, but is it destined to fall further in the short-term?

PA ANALYSIS: Sterling 'flash crash' sign of things to come?

Sterling investors went through hell last week. 

"Mr Hammond, the Chancellor of the Exchequer warned earlier in the week of the rollercoaster ride ahead," remarked Canaccord Genuity Wealth Management head of treasury Iain MacKenzie.  

"I am not sure he expected it to come so quickly or in this way exactly." 

Last Tuesday marked a 31-year low point for the pound against the dollar --- that is, until Friday morning’s ‘flash crash,’ which saw sterling collapse to $1.18 from $1.26 in two minutes during early trading in Asia before evening out at $1.24.

During those tense two minutes, the pound lost roughly 6.1%.

For the moment, the exact cause of the 'flash crash' remains uncertain, though popular theories of rogue algorithms and ‘fat finger’ transactions have been floated.

However, Shilen Shah bond strategist at Investec Wealth & Investment says the movement is further proof of the market’s anxiety around the UK economy and the prospects of a 'hard Brexit.'  

“A disruptive exit from the EU would be a significant negative for the UK economy with sterling taking the brunt of the pain," Shah said.

"Despite the decent UK PMI prints early this week, the politics around Brexit are likely to be a key driver for sterling in the near term –highlighting the emerging market-like sensitivity of the currency. The foreign earnings within the FTSE 100 will however continue to provide a hedge against a weak pound." 

The pound has proven especially delicate to any discussions around Brexit, falling 14.5% relative to the dollar since the referendum.

Theresa May’s comments around Article 50 over the weekend, which strongly hinted at her predilection for a ‘Hard Brexit’ scenario, saw sterling lose 4.6% just last week.

The harsher rhetoric coming out of Europe in response to May’s stance hasn’t helped in alleviating market jitters either.

“Sterling is tremendously weak right now and likely to stay weak,” said Wellian Investment Solutions CIO Richard Philbin.

“You could argue that all the algorithm hiccup has done is speed up the process of what sterling was going to do anyway,” he said.

“Though stock markets have done quite well, that doesn’t necessarily mean the UK economy will do well out of it. We could see a double whammy effect where stock markets go up and we go into a recession,” warned Philbin.

While Psigma Investment Management senior investment analyst Daniel Adams anticipates there will be waves of euphoria and despair as far as sterling is concerned, he thinks that we have already witnessed the bulk of the currency move this year. 

“Our view is that further sterling depreciation will be in the margin until we get more clarity as to what is actually happening with Brexit," said Adams.

"May has said that she will trigger Article 50 in March or April of next year. Obviously, that got the move in sterling going.

“A lot will also be dependent on other currencies as well, the US in particular. If the US doesn’t raise rates, we could see sterling strengthen against the dollar," he added.

Philbin also agrees that swings in sterling will be determined by volatility in other currencies, and with so many events on the political horizon, from Brexit to the Italian referendum and the US election, the pound, euro and dollar are all vulnerable.

As he puts it: “Right now, we’re looking at ‘the least ugly contest’ when it comes to currencies.”

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