HSBC: The pound is now 'the de facto official opposition to the government'
HSBC's chief FX strategist David Bloom says in a note circulated on Friday that the pound has now become a victim of "FX vigilantes" who are expressing their objection to government policy by selling off the pound.
Sterling crashed 6% in just 2 minutes against the dollar in overnight Asian trade, with commentators blaming rogue trading algorithms.
The "flash crash" caps a terrible week for the pound, which is down almost 4% against the dollar so far this week.
The slump began after Theresa May after Prime Minister Theresa May on Sunday set a firm date for triggering Article 50, which would begin the official process of Britain leaving the European Union.
Things have not been helped by reports that Theresa May is unwilling to bend to the will of financial services in negotiations, signals that a "hard Brexit" - a complete break from Europe - is the most likely outcome, and an estimate that such a departure would cost the UK £10 billion in lost taxes.
HSBC's Bloom points to the South African Rand for guidance on the pound's collapse. Rand collapsed in August after a controversial finance ministry appointment that was swiftly reversed.
You read that right. A top currency analyst is now comparing the pound to the South African Rand. That's how bad things have got.
Bloom writes (emphasis ours):
"We used to have the bond vigilantes. These were the collective that punished western governments via higher bond yields when they vehemently disagreed with policy. This helped keep government fiscal ambitions in check. With QE this mechanism is dead.
"However, for FX it's alive and well. We saw this in South Africa, where they made a quick turn-around after a controversial finance minister appointment when ZAR sold-off heavily. ZAR too saw a plunge in Asia overnight, which like GBP, many tried to blame on "Angry Algos". GBP used to be a relatively simple currency that used to trade on cyclical events and data, but now it has become a political and structural currency. This is a recipe for weakness given its twin deficits. The currency is now the de facto official opposition to the government's policies.
"The question we have asked hundreds of investors throughout the world is do you want to buy a currency that has massive twin deficits with an unknown political direction and for that risk you can get zero rates? In other words, we should have some kind of risk premium which through QE is not showing up in bond markets. It's the currency that needs to offer this risk premium."
Bloom is implying that the Labour Party is no longer in a shape to argue the case for a soft Brexit and so currency traders are having to step up to the plate to do it instead.
But the most depressing line is the one on "a political and structural currency." Bloom is saying that the pound has become a victim of structural issues beyond our control, because of the uncertainty surrounding the Brexit deal. In taking back control of our borders, we've relinquished control of our currency.
It's similar to how the so-called bond vigilantes were able to push European governments to crisis point in 2011 and 2012 by selling off bonds in reaction to loose state spending and budget deficits.
HSBC's Bloom says that the "argument which is still presented to us - that the UK and EU will resolve their difference and come to an amicable deal - appears a little surreal," and, as a result, the pound still has further to fall.
He writes: "The structure and politics are conducive to a currency that needs to fall to a level that causes balance. That balancing act is and has been in our eyes is still a lot lower than where it is today."
Bloom is calling the pound to reach $1.20 and thinks by the end of 2017 it will be $1.10 and at parity with the euro.
Here's how the pound looks at close to 9.50 a.m. BST (4.50 a.m. ET):
