By: Andrea Cohen
We would like to point out how the changes in economic conditions as well as monetary and fiscal policies in the US and UK create an opportunity to gain from trading the USD against the GBP.
Starting with the US. The most important change in monetary policy, in our view, is the shift in what the Fed focuses on when considering action. In the past, the Fed was a rather inflation-oriented central bank; we now see a shift towards employment as a central criterion in its decisions. Last December, Fed Chairman Ben Bernanke made it clear that unemployment was its main concern now. Although on Friday (March 8th) non-farm payrolls number of February surprised to the upside (+236K vs. +165K expectations), unemployment rate remains well above the 6.5% Bernanke highlighted as the Fed’s desired level.
Therefore, although economic conditions in the US consistently improve, the traditional connection between growth and rate breaks. That means that in spite the fact that the risk of inflation is higher now as activity picks up, the Fed is unlikely to act and hike the interest rate. This means that growth poses a smaller risk to the USD than in the past, while supporting it as the currency of the one major market that is actually doing well these days.
For the GBP, we believe that the trend is to be continued a while longer. From a technical standpoint, 1.4857 and 1.4875 are support levels, but these have been breached so many times in the recent past for this currency pair that we don’t think these should be heavily-relied upon.
Interest rate policy, current account balance and deteriorating economic conditions in the UK all pressure the GBP down. A caveat to that is that we recently (past week) have been seeing “smart money” (hedge funds etc.) taking profits on their GBP shorts, after capitalizing on the long recent decline. However, we think the real economic factors will prevail and we think the decline will persist.
In the coming week(s) we anticipate that data coming out of the UK will “remind” markets that although GBP-USD is down more than 8% since the beginning of the year, there is room for more unpleasant news. For example, Industrial Production will remind that production activity remains subdued and that large businesses still don’t respond as well as hoped to policy makers’ attempts to inject considerable liquidity to the system in the form of cheap credit. Inflation numbers will remind that the current leadership is more tolerant to higher process, even in the medium-term. Retail data will remind that although households and small businesses did respond to the credit injection, they still don’t spend enough to jump-start the economy.
All things considered, the GBP is a good “partner” for this trade theme as the USD strengthens and the UK economy continues to lag behind.
