U.S. dollar ‘very much overvalued,’ strategist says

Citi head of European FX strategy Vasileios Gkionakis joins Yahoo Finance Live to discuss currency moves in the pound sterling and U.S. dollar.

Video Transcript

- Well, the Sterling has slumped to a record low against the dollar, thanks to a combination of a soaring greenback and concerns over the UK'S latest budget plans. Speculation has now been ramping up throughout the session that the Bank of England could step in with an emergency rate hike. The euro, by the way, also slumping to a fresh 20-year low today. This, amid major political moves in Italy. The nation now has its first far right government since World War II.

Georgia Meloni, leader of the Nationalist Brothers of Italy leads the block. Joining us now to walk through all of the FX moves for is Citi's Head of European Foreign Exchange Strategy Vasileios Gkionakis. Vasileios, I mean, where to start? Let's start with the British pound. Because you made the call last week that you expected it to reach parity to the dollar. It certainly feels like it's moving in that direction. What has been driving this kind of reaction in the market?

VASILEIOS GKIONAKIS: Well, for sure there is definitely the element of our dollar strength, but as far as Sterling is concerned, it's clearly on the back of the UK fiscal announcements. I think the market is taking the view that these sizeable tax cuts, the biggest tax cuts we've had since half a century now, 1972, which are going to be financed by borrowing predominantly are likely to be unsustainable. And basically, what you're getting in this, an erosion of confidence to the UK economy, and that's why you see Sterling plummeting.

Obviously there is a very high likelihood that the Bank of England may step in for an emergency, as you said, rate hike. I think, if and when that happens, I think will provide some stability. But I think, by and large, it's going to be very short term. I still think, I still stand by the view that Sterling is going-- will have to depreciate further, basically to compensate investors for higher UK risk premium.

- The timing of all this certainly raising a lot of questions. Obviously, the trust government just starting things here, going bold as some would argue it-- going for these kind of tax cuts. But also, you've got the UK dealing with record inflation, not unlike other countries, but the question about why, in fact, this is the time to be doing it, how does it complicate the outlook and the trajectory for the Bank of England as they move to rein in inflation?

VASILEIOS GKIONAKIS: Well, to your first question, about the timing, I think by and large is based on what I consider to be a misconception. It's quite clear, we've heard it from the chancellor, they're targeting 2.5% growth. But the idea, this notion that governments can actually target and deliver on that target has absolutely no empirical and no theoretical backing basically. In terms of complicating the backdrop, it certainly complicates it a lot. First of all, you haven't an already high inflation.

As a matter of fact, the UK is running the highest headline inflation relative to the rest of the G10 economies. And secondly, it will be happening in parallel to the initiation of quantitative tightening by the Bank of England. So basically, you will have Bank of England gradually offloading its stock of government bond purchases in parallel to the treasury flooding the market with gilts.

- Vasileios, the moves in the US dollar against other currencies has just been parabolic. I'm going to pull up our Yahoo Finance chart, and you can see the US dollar index as against a basket of currencies year to date. Up 18%, you've got the US dollar against the Japanese yen, up 25%. How sustainable are these moves, and what will it take to cool off the US dollar?

VASILEIOS GKIONAKIS: Well, first of all, purely from a [INAUDIBLE] perspective, I have little doubt that the dollar is very much overvalued. But that being said, quickly what we find from an empirical perspective is that the two things, when they happen together, tend to be the most favorable environment for the dollar. And that is the Fed hiking rates and, at the same time, global rate, and this is pretty much exactly what we have so far this year.

And I have to say, this is what we're going to get over the foreseeable future. It's pretty clear, the Fed is in very bullish stance. Unconditional statements of today, even that means demand destruction, so further rate hikes yields and our real yields will go higher in the US. And equally, at the same time, we're operating in very sluggish growth, with no prospect actually of coming out in [INAUDIBLE] anytime soon and it's important to watch them. The stimulus being halfhearted, and therefore not enough to bail out global growth.

- Finally, the other Central Bank we've been watching closely, the Bank of Japan, we should point out the only major bank that still has a negative interest rate policy in place. We've been talking about the strong dollar really driving the yen despite the intervention that we saw from the BOJ last week. The argument for a very long time, at least in relation to what's been playing out in Japan, is that a lot of the risk is contained because so much of the debt is held domestically.

When you think about the huge swings that we've seen in the currency and where the BOJ is moving, does that argument still hold?

VASILEIOS GKIONAKIS: Well, look, I think there is a validity to that. One could equally say that if we were that the possible billions significant debt being held by [INAUDIBLE], that would have resulted in a much stronger rally in dollar-yen. The fundamental driver for this year's dollar-yen is, again, a significant appreciation around 25% has been the move in the US-Euro. That seems to be a bit de-linked right now, because of the verbal and the reaction that we saw last week.

But again, I would caution very much that in [INAUDIBLE], especially the ones that are not coordinated amongst different countries, are not typically successful. So I think the Ministry of Finance has made that more two-sided, two-way volatility in the market. Again, I don't think that it will be able to basically be the trajectory higher for dollar-yen.

- We'll be watching Vasileios Gkionakis, Citi's Head of European Foreign Exchange. Thanks so much for joining us.