Sterling downside has fallen out of favor, but we think Sterling remains one of the most actionable themes.
In mid-November, we revised lower our GBP/$ forecast to 1.20, 1.18 and 1.14 in 3, 6 and 12 months, and went short Sterling and the Euro against the Dollar as one of our Top Trades for 2017.
There is, of course, near-term uncertainty in the run-up to the Supreme Court ruling. That said, UK Prime Minister May has signaled that Brexit remains the path forward and that Article 50 will be triggered by March. We think this message is getting lost amid the legal debate. Our view remains that Sterling is not yet 'cheap': our research implies that tradeweighted Sterling could fall around 20-40 percent relative to its pre-Brexit level for the UK current account to close to a 1.5 percent of GDP target (Exhibit 4), and that Cable could fall a cumulative 25 percent in response to the large uncertainty shock to the UK economy
The main reason why we expect Sterling to fall further is that the political uncertainty linked to the process of leaving the EU and renegotiating trade agreements is, and will likely remain, elevated for a long period. The process has not yet begun and, when Article 50 is triggered, uncertainty will increase further: what kind of deal the EU and UK agrees on will likely remain unclear for some time. The main economic consequences are twofold: an economic slowdown owing to elevated political uncertainty that reduces investment, employment and consumption, and an adjustment to the UK external balance requiring a substantial decline in the current account deficit, particularly in the event of a "hard Brexit.