Want to see the U.S. dollar’s future? Watch the fall of the pound
Short-term politics trump long-term economics. That’s the message in the beating administered to the pound yesterday.
The implications for the United States are rather depressing.
The pound got killed yesterday (March 1), falling almost four cents against the U.S. dollar and dropping below the $1.50 level that has provided major support.
The reason? New polls that show that the Conservative Party lead in the next election, expected in May, has just about evaporated and that the country faces the real prospect of a hung parliament with no party in an overall majority.
The financial markets had been willing to cut the pound some slack despite a big current budget deficit and an economy where growth lags both the euro economies of the continent and the United States because of the belief that a Conservative Party victory would result in immediate spending cuts. But that relative optimism is in short supply now that the currently ruling Labor Party is within 2 percentage points in the polls. Experienced election observers say that the electoral system in the United Kingdom could well leave the Conservatives short of a majority even if the party wins the election,
The price of 10-year government bonds, called gilts, has not only plunged but is now trading below comparable Italian and Spanish 10-year bonds.
The yield on 10-year gilts is now 0.976 percentage points above the yield on the benchmark German 10-year bonds, called bunds.
That’s not especially surprising given that the German budget and economy are both in better shape than their U.K. counterparts.
But the rout in the pound has pushed the yield premium on gilts above the 0.827 percentage point premium on Italian 10-year bonds and the 0.725 percentage point premium on Spanish 10-year bonds.
Trouble in Japan and the U.K. add up to a stronger U.S. dollar
Expect the dollar to keep moving higher in the near term.
Credit rating worries in Japan and disappointing economic numbers in the United Kingdom pretty much guarantee that the U.S. dollar will continue to gain on the yen and the pound.
On January 25 Standard & Poor’s lowered its credit outlook on Japan’s AA-rated sovereign debt to “negative” from “stable.” Japan’s government doesn’t have a plan to cut its budget deficits, S&P said. The cost of protecting against a default on Japanese government debt within the next five years in the derivatives market rose by 0.05 percentage points to 0.9 percentage points.
The long-term worry is that Japan’s aging population and stagnating economy will eat into one of the world’s largest pools of savings. Domestic Japanese investors hold 90% of the country’s debt.
The next financial crisis has a name and it’s the United Kingdom
It’s one thing when it’s Greece or Portugal. A credit downgrade or warning for those two countries isn’t exactly headline news for most investors. For most of our portfolios these are peripheral markets.
Ireland in trouble too? Yawn. Don’t own any Irish stocks.
Italy? What’s new? Italy’s always running a deficit.
Spain? That’s a surprise. Time to check the portfolio. But, whew, don’t own any Spanish stocks.
The United Kingdom? Whoa. Now we’re getting serious. How could the home of Big Ben, the Queen, the Bank of England, the pound sterling, and double-clotted cream be facing a credit downgrade? And maybe even worse. The cost of insuring against a U.K. default in the derivatives market is only slightly lower than the price of insuring against a default by Portugal.
I don’t think the United Kingdom is headed toward a default on its debt. But it is in the midst of a crisis that could reopen wounds in a global financial system that is still healing from the last crisis.
And it’s not even on the radar screen for most U.S.-based individual investors. I’d put a currency and credit crisis in the United Kingdom at the top of my list for huge potentially market-shaking—and unexpected–events in 2010. (For more on the most expected but still potentially market-shaking financial crisis of 2010—that is Japan—see my post http://jubakpicks.com/2010/01/04/japans-huge-budget-gamble-will-push-up-global-interest-rates/ )
Well, put it on your radar screen now. That fast-moving blip is one that you need to be tracking. A financial crisis in the United Kingdom would be bad enough on its own. But I’m 100% certain that the moment a crisis gets down and dirty nasty in London—and it’s certainly headed that way–investors around the world will start asking, If it can happen in the United Kingdom, why not in the United States?
