A Change Has Come

• faithmight
• October 18th, 2009

The central bank dichotomy between the Federal Reserve (Fed) and the Bank of England (BoE) that has supported the breakdown in cable has completely changed since Monday when the GBP/USD printed a new low at 1.5726. That low printed because the market thought the Fed was taking a more hawkish stance than the BoE. However, the FOMC meeting minutes were released last Wednesday and they shocked the market with its dovish character. Just 2 weeks ago, the Chairman himself made hawkish comments that led the market to believe that the Fed was considering tightening monetary policy by pursuing exit strategies much sooner than expected. I was, therefore, in agreement with the market choosing to send the GBP/USD lower and abandoned my call for 1.62 before seeing 1.55.

It turns out, however, that I spoke way too soon. The FOMC minutes painted a much bleaker picture than that held by the markets. Not only is the Fed very cautious about economic growth in the US due to sluggish labor markets but they are also in disaccord about pursuing further quantitative easing. Honestly, the mere fact that they are even discussing expanding QE further than the current $1.2 trillion program is cause for the market to short the US dollar (USD) and send the GBP/USD higher.

In contrast, a BoE official just Friday stated that though further QE does remain an option the BoE will probably pause in November. This comment sent the GBP higher across the board. In addition, it is not lost on the market that there has been a swath of positive economic data out of the UK last week. UK retail sales, consumer confidence, and even core CPI were all higher-than-expected. A rise in inflation keeps the BoE from easing too much and the good economic report is all very bullish for the GBP. In addition, US retail sales were still not very strong and prices are actually declining in the US which gives the Fed the room to ease monetary policy even further if necessary. This data actually supported the dovishness revealed in the FOMC meeting minutes.

Now that fundamentals have compeltely flipped, we have not only returned to the 1.6120 double top area but the GBP/USD has broken that resistance level and has returned not only to 1.62 as I had called 2 weeks ago but has made new highs at 1.6398 which is the whole number preceding 1.65 — a major whole number, large quarter point, and psychological level.

I think this development has revealed an interesting phenomenon in currency flows that GBP traders should be aware of. I tweeted this as well and that is that the GBP strengthens across the board as the USD weakens. Keeping an eye on cable allows us to make trades on GBP crosses with a higher probability of success as the GBP rallies against other currencies when the USD weakens. A great example is the EUR/GBP. Even as we got new highs in cable last week, we got fresh new lows in the EUR/GBP currency pair.

It is so important and critical to success for forex traders to pay attention to fundamentals even if you consider yourself a technical trader. Sentiment can shift just that fast in the markets thereby changing the short term view of a currency pair. Fundamentals provide an edge allowing traders to profit by making trades on the right side of the market even before technicals fully develop and play out on the charts. We started the week with a hawkish Fed vs. a dovish BoE and thereby saw the GBP/USD drop accordingly to new lows. However, unable to get 75 pips below the 1.5750 large quarter point the pair exhausted. The fundamental landscape then changed to a more dovish Fed than BoE and drove the GBP/USD to new highs near 1.6400.

With price finding support at the large quarter point at 1.6250 which I stressed would be an important level to giving us clues of further cable strength, we now have a possiblity to return to 1.65 now rather than push lower to 1.55.

A new trading week lays before us. Positive data here will increase risk appetite which could be just the catalyst to drive cable to new highs. Be alert as cable looks to return to critical levels. What a difference the central banks can make.

But even as this develops, remember to trade what you SEE, not what I think.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

Tickers: EURGBP, GBPUSD

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