Long USD vs short GBP and EUR – Goldman Sachs

Michael Cahill, Research Analyst at Goldman Sachs, chose to go long the Dollar versus an equally-weighted basket of EUR and GBP (with a targeted upside of 10 percent and a stop loss of -5 percent) to highlight the emerging role of the populist shift in politics.

Key Quotes

“While this is no doubt true in the US as well, the political shift in the US looks likely to lead to more expansionary fiscal policy and possibly more protectionist trade policy, all of which would be more inflationary at a time when the US is already close to full employment. The Fed would need to respond, as both Chair Yellen and NY Fed President Dudley said.”

“On the other hand, the populist shift in the UK has consequences that – at least from an economic standpoint – are first and foremost about trade policy, and our models suggest that Sterling needs to fall around 20-40 percent from pre-Brexit vote levels, consistent with our new forecast for GBP/$ to fall to 1.14 in 12 months. As BoE Deputy Governor Broadbent said this week, the BoE faces a more complicated policy tradeoff given the expected decline in business investment.”

“A common pushback we hear is that the Brexit process could be delayed, and may never even happen. Proponents of this view point to the recent High Court decision and speech by Lady Hale, the Deputy President of the Supreme Court. But our read is that both the High Court decision and the point raised by Lady Hale are essentially about the order of the process, i.e. when does Parliament need to be involved, and how detailed does the Parliamentary action need to be? The point raised by Lady Hale – that Parliament potentially needs to repeal and replace the 1972 European Communities Act (ECA) before triggering Article 50 – is really a question of timing.”

“While there was some debate about the timing and the form it might take, it was always generally assumed by both sides that an Act of Parliament would be required to repeal and replace the ECA at some point before formally exiting the EU. That is because, after more than 40 years of EU membership, the UK needs to somehow disentangle itself from EU laws without creating a legal vacuum in the UK. This is not about renegotiating all of the UK’s laws right away, only about how much needs to be done before triggering Article 50. But our main point in all of this is that the timing questions are procedural, and while they could ultimately delay the process, they are not about directly challenging the outcome. On that front, Prime Minister May has been unambiguous and, if anything, more resolute.”

“By choosing to also include EUR on the short leg of the trade, we are essentially taking an agnostic view with regard to EUR/GBP. Indeed, our new EUR/GBP forecast is 0.90, 0.88 and 0.88 in 3-, 6- and 12-months. The slew of elections slated to take place across Europe this year present a number of catalysts for the trade, and we have kept our call for EUR/USD parity on a 12-month horizon unchanged. Given that the ECB is so far from its inflation target, it should not respond to any rising inflationary pressures in the same way as the Fed, although premature tapering from the ECB is a risk to the trade.”