Thursday, August 18, 2011

Sterling - the Only Way is Up?

Sterling - the Only Way is Up?
Daily Forex Fundamentals | Written by Saxo Bank | Aug 18 11 19:27 GMT
Sterling - the Only Way is Up?

Sterling's response to yesterday's truly dreadful July UK unemployment figures and extremely dovish minutes of the August Bank of England's Monetary Policy Committee meeting was very important. Just before these data releases, GBP/USD was trading at approx 1.6420 and, following the figures, dipped briefly to 1.6350 but, within minutes it was back over the 1.6420 level, and did virtually nothing but strengthen throughout the day, eventually reaching a high of 1.6590. There were no other market developments that ostensibly could possibly explain the pound's surprising strength in the period immediately following the data releases.

Now I am no technical analyst, but if 30 years in the foreign exchange market has taught me one thing, it's that counter-intuitive price action, such as this, is an enormously powerful indicator of market positioning and the future direction of a market. This leads one to the inevitable conclusion that the market was extremely short of sterling, going into the releases, as it didn't take a genius to predict the negative outcomes that did in fact transpire.

In addition to extreme positioning, one can construct other, longer-term, fundamental arguments in favour of sterling. Recent data and the global macro-economic landscape have been universally negative - last week's awful UK industrial production figures, the US debt ceiling debate and downgrade, the spread of Euro debt crisis contagion into Italy and Spain, and stock market collapses have all served to create an apparently universal belief that UK interest rates are going to stay at 0.5% well into 2013, and so the market got hyper-bearish on sterling's prospects. The Bank of England has even conditioned us into believing that the current high inflation readings are no problem whatsoever, as they will plummet after Christmas.

All of this adds up to a situation in which the FX market can only receive surprises which would be positive for sterling. Virtually any flicker of life in economic releases will be greeted as fantastic news, and what if inflation doesn't follow the script and just stays where it is now? That would surely finally cause the Bank of England to accelerate rate increases?

Add to this the decidedly choppy waters into which the US dollar is sailing right now. Don't read Treasury Secretary Geithner's lips when he says a strong dollar is good for the US, or Federal Reserve Chairman Bernanke's for that matter. Instead, follow their actions!

There's every chance that Bernanke uses his opening speech slot at the fast approaching Jackson Hole annual central bank conference to repeat last year's performance, when he effectively pre-announced the reintroduction of Quantitative Easing, (QE2). QE3 would be very bad for the US dollar, so declines in risk appetite due to the Euro crisis or stock market collapses would be seen as further justification for QE3 - the US dollar seems to have lost the safe haven status which it has enjoyed since the crises first started in 2008.

The other cloud on the horizon is the Congressional Joint Select Committee - the so-called 'Super Committee' - that will hopefully agree on the implementation of the $1.2 trillion of cuts that were agreed under the recent budget reduction deal. If the committee fails to be able to agree on the measures required, then automatic, mandated cuts will be enacted. Given Standrad & Poor's comment that the unedifying political process around the debt reduction negotiations was one of the reasons why it decided to remove America's AAA rating, then a repeat performance could be very damaging for the dollar.

Finally, and perhaps bizarrely given the state of the UK economy, sterling has taken on a mantle of a kind of safe haven, given the government's seemingly unshakeable commitment to fiscal austerity - just what the market wants to hear nowadays!

Maybe not today, maybe not tomorrow, but over the next few weeks, sterling looks set to benefit.

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