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Cable Nears Record Low On 30th Anniversary Of 'Black Wednesday'

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by Tyler Durden
Friday, Sep 16, 2022 - 01:45 PM

The British pound plunged to its weakest level against the US Dollar since 1985 -- hitting $1.1350 around 0400 ET. Cable's slide comes as recession risks in the UK flourish with a dollar that has been on a tear thanks to an uber hawkish Federal Reserve. 

The Sterling's plunge to a 37-year low comes on the three-decade anniversary of "Black Wednesday" (Sept. 16, 1992), when the pound famously crashed out of the European Monetary System's exchange rate mechanism. At the time, the Bank of England couldn't stop the pound's plunge, even with interest rate hikes and spending billions to prop up FX markets. 

"There was a tense atmosphere inside the bank," Stuart Cole, who joined the BOE just months before Black Wednesday and is now head macro economist at Equiti Capital, told Bloomberg.

"It was the bank against the markets. There was a sense of apprehension where you knew it was going to end badly."

Traders like George Soros, who wagered massive bearish bets on the pound, would later be known as "the man who broke the Bank of England." He made an estimated $1 billion profit during the currency chaos. 

Fast forward to 2022, and in currency land, the pound finds itself under pressure as the macroeconomic headwinds point to recession as the Fed unleashes aggressive rate hikes to get inflation under control - it seems as if the dollar is on an unstoppable upswing, which inversely impacts the sterling. 

When the Fed aggressively raises rates to squeeze financial conditions, it results in only one place to hide: the dollar. 

"[The dollar] tends to perform well when there are concerns of global recession, and there's a risk-off mood in markets. The dollar is a 'safe haven' asset, and you tend to see flows back into the dollar that support the currency as well," Goldman Sachs' head of global FX Kamakshya Trivedi told clients in a note. 

The pound's morning plunge comes as UK retail sales fell at the sharpest pace in eight months in August, amid a worsening cost-of-living crisis and plunging consumer confidence to decade lows. 

"Today's retail sales data just released were terrible," said MUFG analyst Derek Halpenny.

"The sterling-dollar exchange rate has further to fall in circumstances of increased financial market volatility."

New Prime Minister Liz Truss inherited an economic mess as inflation prints at a four-decade high, energy crisis persists, consumer sentiment faltering, and the cost-of-living crisis worsens. 

More notably, PIMCO's Gene Frieda draws analogies between Truss' most recent energy price guarantee plan and the failure of the Sterling peg 30 years ago...

The Truss government’s decision to cap domestic energy prices for households, in order to limit the impact of higher wholesale prices on consumption, is analogous to the UK’s failed exchange-rate peg of 30 years ago.

If wholesale gas prices soar, owing to Russia’s cutoff of deliveries to Europe or because the UK’s own foreign suppliers choose to limit gas exports in order to mitigate the effects of high energy prices on their own domestic economies, the cost of the subsidy scheme could skyrocket.

With the government’s balance sheet exposed to huge potential losses, its borrowing costs would become closely linked to the wholesale price of gas, over which it has no control.

In other words, the UK is establishing a price peg that will be financially difficult to sustain and politically difficult to remove.

Further increases in gas prices would lead to even higher interest rates; given Britain’s high debt levels, a deep recession would almost certainly follow.

There would be no currency peg to break per se, but sterling would still become collateral damage as foreign financing dries up.

High inflation has forced the BoE to boost interest rates when the economy is slowing - leading some to believe that a massive misstep by the central bank could exacerbate the coming downturn. 

Even though the UK's economic outlook is souring, the pound's weakness is a dollar-strength story. The euro collapsed nearly 20% against the greenback this year, arriving at parity in July. 

The UK currency has fallen 16% this year, and the question remains how Truss will halt the sterling's slide into the abyss. 

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