Five Reasons to Short the Pound Sterling

RemixTrades

The Pound Sterling  has extended gains for quite some weeks now. Since hitting  lows in May, it  has been on a steady cruise-control uptrend. There were a few things that helped the Pound gain strength.

The end of the European Sovereign Saga was a critical factor in helping the Pound as it joined the ‘risk-appetite’ train upwards. Additionally, the end of the panic gave the Pound a fundamental boost because the Eurozone is one of the UK’s biggest trading partners.

Nevertheless, panic relief does not tell the whole story about the Pound rally. Another factor that helped the currency was good ol’ words and promises from politicians: “We’re re-balancing our budgets”, “We’re taking austerity measures”, “We’re serious about our fiscal situation”, and the list goes on.

While the intentions of the politicians are good-hearted, the reality of them acting on their words is less promising. When it comes to deficit and spending reduction, history shows that collapse is usually the only mechanism that brings back fiscal responsibility. But that’s just my opinion.

Markets seem to have taken the words of politicians and priced in success for the UK austerity measures and the Pound Sterling. It seems like no one is bothered by things such as the Bank of International Settlements’ statement (via The Telegraph) in April declaring that the UK needs to take “drastic” austerity measures. Politicians are typically hesitant to take small measures, now imagine drastic ones.

Overall, the long-term downside risks to the Pound appear to be the following:

1) Failure to follow through with all the stated austerity measures, especially because tax revenues continue to be depressed due to slow economic activity.

2) The UK’s main trading partner, the Eurozone, is likely to suffer from continued economic malaise and thus decrease demand for UK goods & services and overall trade.

3) The projected budget cuts in the next few years add risks to growth.

4) The rate hike euphoria will likely dwindle down. The dissent from BoE member Andre Sentance from the monetary committee and desire to raise rates created a positive stir for the Pound. However, we’ve seen that fairy tale somewhere else.

At the beginning of 2010, Thomas Hoenig started to dissent from the consensus of the FOMC to keep rates at record lows and urged for rate hikes. Combined with positive US data, the U.S. dollar rallied from the 74 level to 80.

The positive data + dissent story for the UK sounds all too familiar. Yet we all know that rate hikes from the Federal Reserve appear to be very far, far away.

5) Where is the growth coming from? There are always extensive talking points from the pundits about where U.S. growth is going to come from while nobody has been talking about what will drive economic growth for the UK. Like the U.S., the UK is a matured economy with no certain growth prospects in sight.

Overall, the Pound is not in the happy-land many investors are trying to claim. There are serious downside risks to the currency which all traders must keep in the back of their mind.

However, all of the above is mainly long-term, where possibly “we’re all dead.” So let us look at some short-term chart setups for the Pound Sterling.

First, the Pound-US dollar ($GBPUSD) cross is fluctuating around some key levels. It is above major support which includes the daily 200 SMA (labeled “1″ on the chart below), the 23.6% retracement of the 1.4226-1.5997 run [2], and the daily trendline starting on June 8th [3].

At the time of writing, the cross appears to breaking the trendline. If it closes below the trendline and the 23.6% retracement (1.5579), I would be looking to short down to the 200 SMA. If the pair breaks below the SMA, the 1.5300 zone would be my next target.

The $GBPUSD cross is having a hard time regaining the 1.5700 level and will likely be pressured down if equity markets don’t bounce back.

Click on image for larger CHART

Another way to play the possible Pound weakness is the $GBPCAD.  The pair has broken its daily trendline [ labeled "1"] and is looking to close below the 200 SMA on a bearish engulfing red candle. I would be looking for 1.600, followed by 1.5920.

Click on image for larger CHART

With these charts in mind, keep a keen eye out for inter-market relationships. The downside risks in the charts are stronger if supported by weak equities, oil, and soft economic data.


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: ,

You might be interested in:
blog comments powered by Disqus

In partnership with CNN Money Part of the CNN Network