“Before the referendum, we estimated that a vote to leave the EU would lower the sterling trade-weighted exchange rate by 7.5-12.5% once the immediate volatility had subsided,” Smith said. “At the time of writing the effective exchange rate is 9% below the average level recorded in the four days before Friday 24th June. Ordinarily we do not entertain short-term exchange rate forecasts, but these were extraordinary times.”
Smith explained that long run analysis using PPP, Rathbones own ‘behavioural equilibrium exchange rate framework’, business cycle indicators, and technical positioning all suggests that sterling is either cheap or oversold, particularly versus the US dollar but also against the euro and Japanese Yen.
“It is could be argued that the post-referendum environment is akin to a ‘phony war’ and that a meaningful move in either direction is unlikely to occur before the triggering of Article 50 and Brexit negotiations begin in earnest next year,” Smith continued.
Smith noted that the future direction of sterling will be closely tied to the UK’s success in trade negotiations with the EU and other parts of the word.
“If the UK is shut out from the European Single Market and new trade deals are slow to come by, the productivity of the tradable sectors of the economy are highly likely to undergo a profound period of stagnation. In this instance, the longer-term equilibrium exchange rate will shift lower,” said Smith. “That said, given that sterling is over two standard deviations undervalued versus the equilibrium level, any conceivable downward shift here is unlikely to negate the conclusion that the actual exchange rate is still on balance likely to strengthen back towards the equilibrium level over a three to ten year period.”
In terms of the latest changes to Rathbones’ own asset allocation, the firm remains underweight bonds; has made no changes to the overall allocation to equity-risk; and maintained an overweight in diversifiers.
Within equity-like risk, the main changes were trimming its position in the US to neutral; maintaining an overweight to Japan and adding to the equity and debt positions in emerging markets.