Legg Mason Western Asset: Why we’ve moved long sterling vs the US dollar

Sterling’s sharp decline against the US dollar post the Brexit vote has left the pound significantly undervalued, according to Legg Mason subsidiary Western Asset.
Since the June referendum result saw the UK vote to leave the EU, the pound has fallen around 16%, tumbling from $1.49 to its current level around $1.24 versus the US Dollar.
Prashant Chandran, Western Asset’s Global Head of Derivatives, said the scale of the slide had left the pound looking very attractive versus the US dollar, with investors overlooking factors such as the strength of the UK’s current account position versus the US.
“The UK currently runs a 2% current account surplus with the US, and a weaker sterling should only serve to increase exports and thus increase that surplus,” he said. “As a result, we expect GBP to appreciate against USD over time.”
A ruling from the High Court stating the government would have to seek parliamentary approval to invoke Article 50 early next year has been supportive for Sterling . Article 50 would, if passed, cement the UK’s exit from the European Union.
Regardless of the potential impact of politicians, Chandran added sterling also looked cheap versus the US dollar when viewed in terms of its purchasing power parity, another metric used to assess the value of currencies.
“Looking at the GBP/USD rate from a Purchasing Power Parity (PPP) perspective over the last couple of decades, with the economies of the US and UK economies growing at trend rates (3.5% and 2.5%), and with small current account deficits (1% and 0.5% approximately), it gives an average GBP/USD level of fair value significantly higher than current levels,” he said.
Chandran said the Legg Mason Western Asset Macro Opportunities Bond fund has moved to exploit this by going long sterling vs the US dollar, with the Brexit vote and subsequent negotiations creating an opportunity to profit from near term volatility in the currency.
“We’re currently long GBP/USD in the strategy, with a 2.2% position in place, and if there was any further depreciation for sterling we might look to cautiously add more,” he said.