Credit Rating vs. Currency Value

December 4th, 2009 by Evaldo Albuquerque

What Everyone Is Missing When They Look at the British Pound

Like many other currencies, the British pound has been appreciating against the battered dollar lately. However, the U.K. and U.S. share a lot of the same problems, especially regarding the levels of public debt.

It’s easy to see why traders are missing the bad news. All they’re seeing are the bright spots in the U.K. economy. Granted, U.K.’s economy has shown some signs of improvement, especially in the housing market. Besides that, the labor market has stabilized and manufacturing activity has picked up.

So there’s a good chance that inflation expectation will increase in the next few months. As a consequence, traders expect the Bank of England will raise rates to control that inflation. So they’re buying up the British pound.

But all those British pound bulls are missing a crucial point. It’s the reason why the medium-term outlook for the currency is not that bright.

5-year Credit Default Swap Show Increased Risks
of Default, While the Pound Rises

The currency market is categorically underestimating the U.K.’s fiscal problems.

Due to the country’s rising debt burden, the rating agency Standard & Poor’s has already lowered the outlook on the U.K.’s AAA rating from “stable” to “negative.” If the U.K. government doesn’t address its fiscal mess, a downgrade will certainly be the next step.

In fact, the chart above shows that the cost of insuring U.K. government debt against losses (measured by Credit Default Swaps) has been increasing lately. It now costs more to insure top-rated British debt than it does Slovenian bonds, graded AA by Standard & Poor’s.

So prices in the credit market definitely reflect a higher risk of a credit downgrade. The British pound, on the other hand, has been holding its ground above the 1.65 levels. Something’s out of whack here. That means something’s gotta give!

Have a good weekend,

Evaldo Albuquerque

TagsTags: , , , , , , , , , , , , , , , , , , , , , , , , , ,

Posted in Currency Markets
Similar Currency Trading Posts

  • S&P: U.K.Outlook Revised To Negative
    The sovereign downgrade monster is back on the rampage. Earlier today, S&P fired a blank shell straight at the heart of the usurper formerly known as the developed world, when it put UK's credit outlook on negative. The premise: debt/GDP


  • Why S&P Lowered Its U.K. Debt Outlook
    From Standard & Poor's RatingsDirectOn May 21, Standard & Poor's Ratings Services revised its outlook on the United Kingdom to negative from stable. At the same time, the AAA long-term and A-1+ short-term sovereign credit ratings were affirmed. Rating outlooks assess


  • Ratings Fears Roil Markets
    U.S. stock futures slipped Thursday, as Standard & Poor's move to lower the U.K.'s credit-rating outlook raised fears that a downgrade of the U.S. government's debt rating could come soon as well.


  • Out With flux, In With Risk Aversion
    Unsurprising though it may be, risk aversion kicked in a notch overnight as news of a potential downgrade within a month by Standard & Poor’s for Greece. Such a move would leave its long-term debt rating on the border of


  • Brits Pounded As Debts, Deficits Hit Home. Next Up: Us!
    Boy are things getting ugly in the U.K. The British currency, the pound, is getting crushed. The price of long-term British debt securities, called gilts, is heading down. And the cost of default insurance on the country's debt is rising


    • Leave a Reply

    Security Code: