Friday, 9 August 2013

A Trade in the British Pound?

Ralph Shell, Excel Analyst

August, so far, has been a good month to be long the British pound.  On the 1st, the GBPUSD, (FXP, UUD, UDN) was close to 1.51, but since has rallied smartly to a high yesterday of over 1.5570.  Most of this week's headlines are about the euro strength; however, that move pails in comparison to the rally in the pound. The best the euro could do was a move from 1.3230 to almost 1.34.

This pound rally was caused by good economic news at a time when specs were committed to the short side of the pound.  We noted in our last COT report the specs were short 63.9K contracts of futures and delta adjusted options at the CME.  With the total open interest only 173K, this is a sizable share of the market.

On Tuesday, 06 August, the estimate of the UK Quarterly growth was +0.7%, up from the last estimate, 0.6%.  Wednesday, the Bank of England increased their estimate of UK growth from 1.2% to 1.4% this year, and the 2014 estimate was raised from 1.7% to 2.5%.  Yesterday, the Organisation for Economic Co-Operation and Development (OECD) raised the outlook for the UK economy.

Pound traders have been concerned the new superstar BoE Governor, Mark Carney would engage in additional QE and thereby weaken the pound.  At the first BoE meeting chaired by Carney, they opted to provide forward guidance of the bank's intentions. An increase in the bank's loan portfolio was not part of the new policies.  

Currently the bank of England bank rate is a low 0.5%.  The BoE said they would keep the interest rate at a record low until the unemployment went below 7%.  Carney said:

"...a recovery in Britain's economy was underway and appeared to be broadening but had a long way to go.

"We're not at escape velocity right now," he said at his first BoE news conference. "This remains the slowest recovery in output on record."

Click to Enlarge GBPUSD Daily Forex Chart
GBPUSD Daily 08 August 2013, Excel Markets Analysis

With the forward guidance in place, and a modest recovery unfolding, is it time to be long the pound versus the USD?  Buying a new high can work if you get in the move early.  In this case, the high comes at a level which is bumping the 200-day SMA. The last challenge of this MA failed - a big 900 pip break followed.

We understand the case for the long side of the pound but it currently seems over-extended.  Part of the rally in the pound is merely USD weakness.  Traders have been USD long and short everything else.  There appears to be USD selling against the yen and the euro, in addition to the pound.  As those shorts come off, the pound gains by default. 

We would be willing to try the long GBPUSD on a set back to the 1.54 handle.  Failing that sell-off, we will remain on the sidelines.
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