April 23, 2020 / 3:34 PM / 3 months ago

COLUMN-Sterling a possible outlier in selective rebound: Mike Dolan

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Mike Dolan

LONDON, April 23 (Reuters) - When world markets cratered on pandemic shock two months ago, the selloff was indiscriminate. The recovery is already proving far more selective for stocks and some banks now reckon sterling could end up as a negative outlier in the currency market.

Global stock markets and most risky assets collapsed in tandem in late February as the extent of the virus's spread made it clear that subsequent lockdowns would lead to the biggest global recession in almost a century.

Few, if any, countries or companies were likely to escape. The peak-to-trough drop for the MSCI all-country stock index was 34% in a space of just 23 trading days, bottoming out on March 23 as the scale and speed of more than $12 trillion - and counting - of monetary and fiscal support became clear and steadied the ship.

For many investment funds, the second quarter of 2020 is now a complete write-off and details about the depth of the economic hit already taken almost irrelevant to pricing assets. What happens next is key.

The more selective rebound now is seeing investors focus on everything from differences in national lockdown trajectories and popular behaviour to debt accumulation, commodity-exposure and relative corporate balance sheets, payouts and survival prospects.

In that light, warnings from the UK government's chief medical adviser Chris Whitty late Wednesday that some form of social distancing measures would be required for the rest of the year were eye-catching against a stream of plans from other countries on gradually lifting lockdowns from this month.

The UK lockdown is officially in place for another three weeks, in line with many other major economies, but Whitty's remarks suggested the process of re-opening may be slower.

Banks such as Deutsche Bank make the case that Britain - and by extension sterling - could well be a laggard as the major developed economies get back to work, and it cited two main factors.

The first centres on the still low level of virus testing relative to other rich economies, despite ambitious targets, and also opinion polls showing relatively high levels of support for a "hard lockdown" in Britain. Both these may affect the speed with which the country will likely re-open, it argues.

Even government minister Brandon Lewis on Thursday described the lack of virus testing in the country so far as "dreadful".

The second factor was the relatively high exposure of a very services-dependent UK economy to prolonged distancing and economic disruption, with Deutsche citing data showing consumption makes up a whopping 84% of the economy - more than any other major economy apart from Brazil and Argentina.

Britain's Office for Budget Responsibility last week forecast the UK economy would contract by 35% in the second quarter - more than three times similar estimates for manufacturing and export-heavy Germany.

"The UK appears to be caught in a double whammy," wrote Deutsche Bank strategist Oliver Harvey. "This should ultimately translate into a relatively harder hit to growth and, on a structural basis, be bearish for the pound."

WHAT'S PRICED?

For others, there is no shortage of reasons to be bearish on the pound - not least the currency's vulnerability to large UK balance of payments deficits.

The return of Brexit concerns add to the anxiety. The UK government insists that despite the pandemic uncertainties, it will not extend the Brexit transition period beyond the end of 2020 - even though no subsequent trade deal with the European Union has been negotiated, nor is one in sight.

Like most central banks, the Bank of England has cut policy interest rates to a record low, of 0.25%. But its planned bond-buying and balance-sheet expansion by about a fifth of national output is more than twice the equivalent European Central Bank measure, even if still less than the Federal Reserve's stimulus.

Yet currency markets don't yet appear fully priced for a UK exception.

Sterling was certainly one of the biggest losers against the supercharged dollar amid the initial shock - losing more than 10% in the month to March 23 and more than 9% on a trade-weighted basis. But it has rallied more than most since - about 7% on the dollar since March 23, as tensions eased.

What's more, speculative positioning in the futures market still shows a net long position in pounds that's been in place since December's UK election - albeit after about a year-and-a-half of consistent Brexit-related net shorts.

The UK equity market appears more wary. Domestically facing FTSE midcap stocks have underperformed the MSCI all-country index by more than 11% since the February 20 highs - and also underperformed the more globally sensitive FTSE 100 bluechips by about 7%.

UK government bond prices have also underperformed, even if the resulting narrowing of benchmark yield spreads may provide the pound with some support as a result.

However, speculation that the post-pandemic world will lead to higher inflation worldwide may affect sterling more than most as long-term inflation expectations embedded in the bond market are already structurally higher for Britain.

And while this month's IMF economic forecasts show the expected 6.5% UK output contraction for all of 2020 to be less severe than the three major euro zone economies, the organisation also expects next year's 4.0% rebound to lag all G7 economies except Japan.

By Mike Dolan, Twitter: @reutersMikeD; Editing by Pravin Char

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