Am I availing myself of any old sterling excuse?

In the interregnum between voting to leave the EU and actually doing so, I claimed the UK’s final exit would prove largely seamless. And, in being seamless, it would completely remove the weight of uncertainty holding down sterling. My expectation has been for sterling to ‘gap up’, that is, having so shockingly ‘gapped down’ in the wake of the referendum, and the awakening of concerns it would prove a bitter separation. As we know, almost a year after formally leaving the EU, widespread uncertainty persists as to the final form Brexit will take. Widespread uncertainty there may be, but not to my mind.

I have no doubt that for all the political jawboning about ‘tearing up’ the Brexit deal, forcing hard borders to go up all around the UK, nothing of the sort will happen. For me, before too long, all will see this with clarity. Until then I have to accept the generally negative sentiment towards the future of the UK economy and the pound. But I ask that all accept that this is not the first time the mood towards the UK has been dark, only to then quickly lighten. 

I wish to point to what I believe in part explains why, when sentiment towards the UK economy and sterling has historically moved up, it has done so in significant, dramatic ways. None will challenge the claim that London is a significant commercial currency trading hub. And for all the technology at play in London, traders are still very much at play. What inevitably comes with mere flesh and bone traders are those cognitive shortcomings we mortals are so susceptible to; one of these being availability bias. The concept is as simple as it is frustrating.

When an event is playing out generally, the attention availed to in the UK tends to exaggerate its localness. When traders hear as they have very recently of supply disruptions, shortages and dislocations hitting the UK, they too often fail to recognise how precisely the same challenges are confronting the EU, the US and beyond. The result of the failure to see the UK’s relative position as unchanged is to erroneously shift sterling’s relative price against other fiats, i.e. amplify its exchange rates.

The concentration of FX trading in London is a fact. A fact too that currency dealers read pages and screens written from a very much London-centric perspective. It is this parallax which leads to the availability biases I claim exist in exaggerating sterling’s weakness. Biases which on the occasions the UK is reported to be enjoying favourable winds, exaggerate its comparative strengths by failing to contextualise its performance. Just as it moved suddenly higher from late 1996, and more recently 2013, sterling must do so again in the near future. When it does it will come as a surprise to only those who have not studied the pound’s past and are not more widely read. 

Let me turn now to another cognitive skew which plagues the investment advisory world, that of confirmation bias. Here we have the frustration that data is used to validate a preferred recommendation, as opposed to the latter tailored to fit reliable evidence.

There are three quite different confirmation biases to mention. One is data mining, the relentless digging for ‘facts’ until figures are found that support an investment recommendation. A second ruse is data misrepresentation. Here figures are interpreted in a way that plays to a particular belief. Consider the UK’s labour market. The evidence of worker shortage has been used as a stick to beat those who suggest a strong period ahead for the UK’s economy. The inference is that these shortages will either continue to frustrate the UK’s economic progress, or result in a surge in wage and price inflation and their spiral that the BoE is forced to rapidly tighten in a way that frustrates the economic progress. Or put simply, lose, lose.

Now, whilst a shortage of labour is a challenge for any economy, it is definitely preferred over a lack of jobs relative to the number in need of work. Indeed, if those out of work have the skills and talents that suit the jobs being advertised, then labour market matching will be swift, and a strong and quick economic recovery assured. Here then we have the same data being interpreted diametrically differently.

A third confirmation bias ruse is that of using a consequence of a prejudiced recommendation to confirm it is in fact accurate. None can doubt that sterling sits where it does largely because of the negative sentiment towards the UK; if all underweight recommendations turned to overweight ones, sterling would strengthen. And yet the investment institutions looking-down on prospects for the UK economy point to a weak pound as evidence to support their assertion. Here, then, we have two issues. One is self-fulfilling circularity; to wit the pound’s level is a manifestation of recommendations, not proof they are correct. The second issue is that rather than cause for concern, one could easily argue that the lowly level the pound sits makes it more competitive than otherwise. One could go on to claim that misplaced concerns over the tearing up of the Brexit Deal are less negatively pressing on the UK economy than those of Ireland and many other EU nations.

How then can the same investment advisors recommending being ‘underweight’ the UK not be similarly disinclined towards Europe? Too often these are precisely the inconsistencies that we see. Indeed, those who bemoan the UK economy whether it has a dearth of vacancies or a glut also see dark economic clouds over it, whether the pound is comparatively ‘low’ as now, or more elevated as it will be again. However, when those across finance capitulate and turn positive, the undershooting of UK financial metrics turns to over exuberance.

Prejudice and inconsistency abounds in the world of investment advisory. We should all try to not be bound by the narratives coming out of the sell-side because all too often they will suddenly correct their recommendations, doing so, that is, under the euphemism of “revising” them.