Expect the Dollar to Strengthen Against the Pound

 |  Includes: FXB, UDN, UUP
by: Alpha Author

A friend and colleague of mine who accepted a job at a European university jokingly explained in an email yesterday that his move to London could easily be explained by the fact that he had always wanted to become a currency speculator. I asked whether he really want to bet against the Dollar, or for that matter, for the Pound. He preceded to ask me what I thought about the strength of the Dollar, and the strength of the Dollar vis-a-vis the Pound.

I wrote the following, off-the-cuff response (edited slightly to censor expletives and to improve readability):

In my opinion there are a couple of forces impacting the value of the dollar right now.

  1. Dollar as a “flight to quality” vehicle (pushing it up).
  2. Dollar as a debased currency with the Fed/Treasury programs of fiscal stimulus plus quantitative easing (pushing it down).

The question then becomes which of these effects represents the stronger influence.

Although the dollar has weakened recently, I believe the “flight to quality” effect will dominate in the near term with the dollar strengthening over the next 6 months or so. Eventually however (looking 1 to 2 years out), the debasement effect will kick in leading to a fall in the value of the dollar.

That opinion, however, only addresses the Dollar versus a basket of world currencies, not necessarily the Pound.

With respect to the USD/GBP, it becomes a relative game with respect to the two effects above. Specifically, is the dollar a stronger “flight to quality” play than the pound and/or is the Bank of England debasing the Pound faster than the Fed/Treasury is debasing the dollar?

I think the answer to both is an emphatic yes. At this point, the Dollar remains a stronger “flight to quality” vehicle than the Pound given its higher status in the pecking order of reserve currencies. In addition, although the US recession has been severe by almost any metric, the situation is actually worse in the UK, leading the UK to engage in larger relative programs of both fiscal stimulus and quantitative easing.

For these reasons, although I feel that the value of the dollar will decrease with respect to world currencies in the long term, I expect the Dollar to strengthen vis-a-vis the pound.