The GBP has long held the mantle as one of the most stable currencies in Europe, and indeed the world. The United Kingdom can certainly lay claim to a structurally sound economy, and the currency reflects as much. From a strategic perspective, I would recommend going long on the GBP against the USD. If you gauge market sentiment, you will see that most traders are going long on this particular currency pair (over the long-term), and it is at its highest level since April trading when it was $1.46. But something interesting been happening over the past couple of days – the GBP/USD currency pair has been falling for several consecutive sessions. This marks the longest-running losing streak for the Sterling in 6 years. Sensible advice is the following:
- Strategically, the GBP/USD is a call option (up to a year or more)
- Tactically, the GBP/USD is a put option (days and weeks ahead)
What is Causing Short-Term Weakness in the GBP?
It is clear that multiple factors are weighing heavily on the pound. These include poorer Purchasing Managers’ Index data in services, manufacturing and construction. On 18 September 2014, a referendum on Scottish independence was held and the majority decision remained in favour of union with the UK. However, a new survey conducted by STV (Scottish broadcaster TV) now reflects that the majority of Scots are in favour of independence. This is also adding downward pressure on the GBP. The British Prime Minister – David Cameron – is now compromising on the question of UK membership in the European Union. It is expected that the referendum question will be: Does Britain wish to remain in the EU, or leave the EU?
These issues are important determinants of global sentiment vis-a-vis the GBP. Negative responses such as a UK departure from the EU, Scottish independence and declining economic data naturally affect the strength of the British currency. As a trader it's all about looking for opportunities in the short-term to profit off the volatility. The aforementioned factors are definitely negative and have a bearish effect on the currency. Outside of the UK, the September 16-17 FOMC meeting is the most pressing issue for the GBP/USD currency pair. As expectations of a rate hike in the US increase so the GBP will weaken. Should key individuals like Janet Yellen or Stanley Fischer make comments to the contrary, the GBP/USD currency pair will appreciate. My feeling is that the likelihood of a rate hike is higher now than it was a week ago, although I would not describe a rate hike as a certainty just yet. In terms of trading decisions – put options on the GBP/USD currency pair are definitely gaining favour with traders.
Important Macroeconomic Decisions in Europe
Mario Draghi of the European Central Bank is looking at additional quantitative easing and related measures to stimulate economic activity in the European Union. When the president of the ECB announced a complete revamp of the QE plan for Europe, the Euro dropped to a 2-week low. Of course it makes sense that additional monetary policy stimulus measures are enacted in Europe, especially given global market weakness. Recall that the euro had gained approximately 3% against its peers in August, on the back of a current-account surplus. Analysts are expecting the European currency to hit parity within a year, and possibly fall as low as $1.10 over the short-term. Therefore, put options on the EUR/USD currency pair are also a viable trading opportunity. The more euros flooding the markets, the cheaper the currency becomes vis-a-vis a basket of currencies.
GBP/EUR Currency Pair 1-Month
If we analyse the performance of the GBP against the EUR a week ago, it was trading at 1.3801, before slumping to 1.3523. This was attributed to United Kingdom Net Consumer Credit Data for the month of July. The manufacturing PMI for the month of August also fell below forecast expectations. Currently, the currency pair is trading at 1.3608. Against the dollar, the pound performed even more poorly. On Monday, 31 August the currency was trading at 1.5433 and by Friday, 4 September it was trading at 1.5219. It should be remembered that US economic data supported a strengthening USD. One such measure was US non-manufacturing composite which was expected to decline to 58.2 points, but instead only declined to 59 points from 60.3.
To sum up
- You might consider shorting the GBP and go long on the USD in the days leading up to the September 16-17 FOMC meeting (GBP Put Options and USD Call Options)
- You might shorting the EUR as long as talk of quantitative easing by the ECB persists
Expect high volatility in the currency markets in the coming week.
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