It's time to sell the pound
John Stepek Oct 02, 2012
As the printing presses continue to churn around the world, who is benefiting from all this money printing and easy lending?
So far, the answer seems to be: ‘the banks’.
In both the US and the UK, central bankers are trying to lower funding costs for banks. If it’s cheaper for banks to borrow money, they should be keen to lend more. Instead, banks are merely using the cheap funding to boost their own profits.
There’s not much sign of the man on the street getting their hands on much of that central bank money.
However, there’s one key difference between the two countries that suggests the US will be more successful in boosting its economy than the UK – the state of the housing market...
America’s big advantage over the UK
It’s early days yet, but in the UK, the Bank of England’s ‘funding for lending’ scheme shows little sign of having much impact on borrowing costs for small businesses and individuals.
And in the US, the latest bout of quantitative easing http://www.moneyweek.com/qe (‘QE infinity’, as it’s now known) has boosted banks’ profits on new mortgages, rather than cutting interest rates on home loans.
The Fed’s promise to keep buying mortgage-backed bonds has driven up the price of these bonds as investors pile into them. That means that banks creating new ones are suddenly making a much larger profit on them than they did before the Fed’s announcement.
But they’re not passing this profit on to customers in the form of lower loan costs. They’re just keeping the extra cash. That’s not necessarily what the Fed wants, says the FT.
“The extent to which QE3 drives down mortgage rates and helps homeowners or is pocketed by banks will be crucial to the success of the policy and the prospects for growth in the US and global economies next year.”
It sounds on the surface as though central banks in Britain and the US are grappling with similar problems. They want their freshly minted money to flow through to homeowners, individuals, and businesses. But those greedy banks are using it to boost their profits instead. Who could have guessed such a thing would happen?
However, there’s a critical difference between the situation in the US and the situation over here.
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In the US, mortgage rates are already cheap. In fact, the average rate on a 30-year fix (they have those in the US) hit a record low of 3.4% this week. Yes, it would be lower “if banks passed on the full drop in their funding costs,” as the FT notes. But it’s still a pretty impressive deal by anyone’s standards.
More to the point, house prices have also been allowed to fall. By most measures, prices are now at or below fair value. So the US housing market is already well-positioned for a recovery. It doesn’t actually need QE infinity to recover. There may not be a fresh housing boom any time soon, but nor is a second devastating crash a huge threat.
That means the banks are free to use QE infinity to boost their own profits. And the more profit the banks make, the healthier their balance sheets will be. The healthier the banks feel, the more inclined they’ll be to lend.
In Britain on the other hand, the only thing that’s keeping the housing market afloat is the constant intervention of politicians and the Bank of England. Our entire political system currently seems bent on recreating another housing bubble.
First we had Nick Clegg’s stupid idea about raiding pensions to pay for deposits. Now Ed Balls is talking about how he’d use (as-yet-unrealised) profits from selling off 4G licences to fund a stamp duty tax break. The horrible truth is that our politicians understand only too well that the average British voter’s view of how the economy is doing, boils down to whether or not their house rose in value last month or not.
But this leaves us in a much worse position than over in the States. Banks don’t want to call in bad debts, because that would trash their balance sheets. But they don’t want to do more lending, because they know they have all this potential trouble stored up. So they’re still in retrenchment mode, with no real sign of light at the end of the tunnel.
The best way to play a stronger dollar
In short, while there are plenty of risks, the outlook for the US is healthier than the outlook for the UK. So how do you play this? The trouble is, the US stock market has priced in this sunnier outlook. Indeed, the market as a whole looks expensive, judged on long-term measures such as the cyclically-adjusted price/earnings ratio. So given that there are still plenty of hurdles along the way to recovery, we’d be wary of buying the US stock market at current levels.
However, one area where the US doesn’t look expensive is in the currency markets. The dollar hasn’t been hit as hard by the promise of QE infinity as you might expect. But it’s hardly been soaring ahead either.
If you’re comfortable with spread betting, you might want to short the pound against the dollar. The pound’s high for the year was just above $1.63. It’s now trading very close to that, at around $1.616. A short bet from here with sensibly-placed stop losses looks like it offers a decent balance of risk and reward.
Bear in mind of course, that with spread betting you can lose far more than your original stake. If this is the sort of thing you’re interested in, you should sign up for our free MoneyWeek Trader email to learn more about spread betting techniques.
If you’re not keen on the idea of spread betting, the good news is that you can profit from a stronger dollar anyway. Many of the UK-listed blue-chip dividend stocks that we’ve been recommending you hang on to earn significant levels of dollar revenues, and so benefit when the dollar strengthens.
• This article is taken from the free investment email Money Morning.
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