When in doubt, the British blame a Frenchman. François Hollande, France’s president, heads the narrative around the flash crash in the pound that occurred as Asian markets opened on Friday. His comment that the UK would endure a “hard Brexit” from the EU came just before sterling fell more than 6 per cent in two minutes.
This was equivalent to the second-biggest daily fall for sterling since Richard Nixon ended Bretton Woods and ushered in floating exchange rates in 1971.
But this cannot be put down to an intemperate French politician and a trader’s fat finger. Volume was thin as Asian markets set to work, but thin volume often combines with an excuse to buy or sell sterling. It had never before fallen this much so quickly. And 12 hectic hours later, it was still at a 35-year low against the dollar. even though so-so employment data in the US should have lifted some of the pressure on the pound (and even though British macroeconomic data look reasonably strong).
British politicians - led by the new prime minister Theresa May - should not blame foreigners, but re-examine another basic British political impulse. When in trouble, British politicians have a strong tendency to throw their currency to the wolves.
Mrs May and her supporting ministers served up a cocktail of nationalism and statism at the Conservative party’s conference this week that could almost have been designed to push the pound down. Controlling migration will trump other considerations in Brexit negotiations, central bank independence is in question, and UK employers will be required to list their foreign workers. It is hard to imagine a more market-unfriendly version of Brexit.
‘Twas ever thus. As Simon Derrick, foreign exchange strategist at BNY Mellon, points out, allowing the currency, rather than the local markets, to take the strain has been the “default option” for UK politicians for a century. Leaving the gold standard in 1931 and Harold Wilson’s 14 per cent devaluation in 1967 are the most spectacular examples.
Since 1971, there have been seven times when the pound fell 15 per cent or more against the dollar in the space of six months. Presently, the pound is down only about 12.5 per cent against the dollar over the past six months. The lack of any UK political reaction to the currency reactions suggests tacit collusion in devaluation is again under way. This helps to perpetuates the (false) belief that strong UK market performance in pound terms is evidence that Brexit is not creating the damage feared.
The price is likely to be inflation, and with it an end to the easy monetary policy which the Bank of England has so far used to help buffer reactions to the referendum result. Judging by break-evens on the gilt market, comparing yields on inflation-linked and fixed bonds, the market now expects average UK inflation of more than 3 per cent over the next decade. This is the highest number since early 2014, and more than double the figure for the US.
Even if the fall has more to do with UK politicians’ fecklessness than fat-fingered forex traders, those traders still contributed to the mess. They did a horrible job trading the referendum, after unaccountably convincing themselves that a Remain vote was a foregone conclusion.
Rather than learn their lesson, they then convinced themselves that the UK and EU would reach a compromise that left the status quo intact. Confronted this week with clear evidence that they were wrong, they again inflicted a disorderly sell-off on themselves.
Why persist in this behaviour? It can partly be put down to the well-worn narrative of wealthy elites out of touch with populist currents in the population. But plenty of London forex traders voted to leave the EU, and they tend to be a dispassionate breed who look at the data, balance the odds, and make their trade.
Rather, forex traders’ mistake seems to be in the way they deal with binary political risks. Steven Englander, Citi’s chief forex strategist, nailed the strategy last weekend: Baffled by the lack of volatility or hedging despite great political risks, he said investors were assuming “that it will be much easier to be the second one in the door of a soon-to-be-very-crowded theatre than it would be to be the first one out of a burning one”. They thought they could await news and react then, not hedge in advance. This means crashes and overshooting, unaided by fat fingers or algorithms.
They may be making the same mistake over the US election. And note that the next big event, the second presidential debate on Sunday evening in the US, will take place during the hours of thin Monday morning trading in Asia.)
Like British politicians, and perhaps British voters, FX traders took false comfort from the calm that followed the one-off shock of referendum night. That calm has been broken. The British have chosen a course that means isolation, and higher inflation. And they cannot blame the French.
