British Pound and S&P500 Decoupling?

By Mike Conlon

Sound As A Pound No More!

The British pound (GBP) was weak across the board Wednesday as BOE Governor King re-iterated that a weaker currency should lead to a recovery in the economy. This comes on the heels of a better than expected unemployment report, though not enough to buoy the sentiment for a rapid economic recovery.

As a result of subdued growth prospects, the BOE increased its quantitative easing program to $200 billion pounds last week to pump liquidity to the financial system. Some have argued that their conservative, controlled approach to asset purchasing was a major reason why GDP shrank an unexpected .4% back in October, as other nations were exiting recession.

Also to note was that the BOE said that inflation will stay below it 2% target for the next three years, thereby all but confirming that deflationary pressure is the concern for today. As a result, don’t expect any interest rate hikes anytime soon. In fact, a Bloomberg survey of economists showed that the median thinks they will maintain rates at .5% until the Q3 of 2010. This also leaves open the door for increased asset purchases going forward.

As I wrote in an article back in September, I couldn’t envision the pound falling against the U.S. dollar in the near-term as, “Bernanke’s path to dollar destruction has been well-documented”. But I did caution against the pound in the long-term as the problems that are inherent in the British economy are coming into play today. Since that time, GBP/U.S.D did decline further before going on a tear from mid-October until now.

Here’s a good article from BBH’s Marc Chandler from yesterday presciently calling for GBP weakness.

One of the other things I talked about in my previous article was the pound’s positive correlation to the S&P 500. Here’s a chart of the British Pound ETF (FXB) and the S&P 500 (SPY).

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Well since that time, it looks like this correlation has stalled and we could be in for a possible decoupling of this correlation.

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Or could this move down in the pound be foreshadowing a move down for the U.S. equities markets? Now that earnings season is all but over, there doesn’t appear to be a catalyst that will move the stock market higher other than Bernanke’s commitment to dollar weakness.

If we do see a pullback in the U.S. equities market, then expect the U.S. dollar to strengthen as the risk aversion trade is sure to hold up.

Either way, I expect a bit of fireworks in the New Year!

Disclosure: The author may hold a position in some of the securities/currencies mentioned in the article.

Original article