“The bulls are like the giraffe, which is scared by nothing or like the magician…who in his mirror made the ladies appear much more beautiful than they are in reality. They love everything; they praise everything; they exaggerate everything.
The bears, on the contrary, are completely ruled by fear, trepidation and nervousness. Rabbits become elephants, brawls in a tavern become rebellions, faint shadows appear to them as signs of chaos”
Joseph de la Vega
‘Confusion de Confusiones’, 1688
When it comes to our views on the pound sterling, there have been certainly times during the past year when we felt a little bit like Joseph de la Vega’s proverbial bears, mistaking the ‘shadows’ of a deteriorating current account deficit and housing and a consumption driven growth model for signs of impending chaos.
We were convinced that GBP was significantly overvalued, even as expectations for Bank of England interest rate rises began to push GBPUSD over the 1.70 level. However, this bullishness was also causing the market to become extremely stretched; by April, according to CFTC data, ‘long GBP’ speculative positioning had reached its third highest level ever. In other words, on only two previous occasions had the investment community been holding as many pounds for speculative reasons. This gave us confidence to maintain our non-consensus bearish view.
In the end, our twelve month GBPUSD forecast of 1.55 (from a January spot of 1.65) looks to have been a pretty decent call.
We did expect the US dollar to be a relatively strong performer in 2014, but in hindsight we underestimated the degree to which the greenback would rally against virtually all of its peers (our biggest error was to underestimate the degree to which the euro would weaken – see below). The reason for this underestimation is easy to identify – as we wrote on February 17th “…we put probability that QE ends in 2014 at less than 50%”. Obviously, QE did end in 2014 – and the dollar ended the year even stronger than we initially expected.
From late 2012 and throughout 2013, we were quite bullish on the euro, largely against market consensus (which was largely correct). However, in January 2014 we began to moderate this call, writing: “our conviction in the euro’s ability to continue to move higher is limited as EURUSD pushes further and further away from its fair value (estimated at around 1.20)…we are now broadly neutral on the single currency…”
Well, while we were right to call the top as EURUSD approached 1.40, we unquestionably underestimated the degree to which the euro would weaken in 2014 – we did expect EURUSD to drop from near 1.40 (where it began the year) to the low 1.30’s during the year (6 month forecast of 1.32), but we did not expect EURUSD drop down to the mid 1.20’s.
We started 2014 with a bullish bias for USDCAD, expecting an appreciation in the currency pair of about 5%. This represented a shift from our largely bearish bias, which we had maintained since the onset of the financial crisis in 2008, and seemed a reasonably aggressive prediction, in light of the fact that USDCAD had demonstrated a range of less than 10% over the preceding five years.
In reality, USDCAD has appreciated by about 10% in 2014 (we did upgrade our forecasts to catch the second leg of this move earlier in the year). The main reason for our initial underestimation of the extent of USDCAD’s rise in 2014? We did not foresee the degree to which the oil price would weaken, which has undoubtedly been the main driver of USDCAD’s rally beyond the 1.10/1.12 level.
We have certainly enjoyed analysing, assessing, and writing about the currency markets in 2014, and we hope you have enjoyed reading our weekly notes. As the year comes to an end, we here on the Validus Research Desk would like to take this opportunity to wish all of our valued clients, colleagues and friends a happy and relaxed holiday season, and a prosperous 2015!
Author: Kevin Lester