British Pound in a Position of Weakness

By: Bryan_Rich

In the past month we’ve seen statistics that indicate the recession for major economies will be ending this year. And in some countries, like Germany, France and Japan, their recessions technically ended in the second quarter.

But do these statistics mean better times are ahead for consumers … more jobs … friendlier lending policies? Does a positive quarterly GDP, rising from the steepest global economic contraction in 60 years, mean that the risk of another shock to the global system has diminished?

Not likely.

In fact, central bankers around the world have littered recent statements with caution about downside risks and the overwhelming environment of uncertainty. Additionally, major economies have made it crystal clear that interest rates will remain low for some time.

The Fed said …

“Conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period of time.”

The Bank of England said …

“Recession appears to have been deeper than previously thought.”

The Bank of Japan said …

“Continued high downside risks to the economy.”

The European Central Bank said …

“Uncertainty is very high.”

Central banks around the world have put out the word that interest rates will stay low for some time yet.

Even the Reserve Bank of Australia, a hawk on interest rates, did not change its bias toward lower interest rates.

And the Bank of Canada meets next week. Considering that the Canadian economy contracted worse than expected in the second quarter, it’s probably safe to assume they’ll be equally, if not more, cautious about the economic outlook.

In all, major central banks around the world have aggressively ratcheted down interest rates. And they’ve made it abundantly clear that market participants are ahead of themselves if they’re looking for moves in interest rates any time soon.

Next, look for official talk of coordinated and telegraphed “exit strategies” to be a heavily discussed topic at this month’s G-20 meeting.

The G-20’s Hypothesis: Coordination Equals Stability

You might recall last April when the top political and financial leaders of the world got together in London. They came away with a commitment to respond to the global recession and financial crisis in a coordinated fashion.

So don’t be surprised if they break this time with a similar message about coordinated exit strategies.

Why work in cooperation with other countries?

Well, the domino effect of the financial crisis and economic downturn around the globe clearly shows how interconnected and interdependent economies have become under globalization.

The traditional response to economic recessions is protectionism. However, trade barriers raised during the Great Depression only served to prolong contraction.

But while benchmark interest rates remain stagnant across the world, there are incremental changes happening.

And that’s where …

A Play on the Pound Looks Enticing …

Last month the Bank of England surprised the world when it announced it would expand its quantitative easing program. So after winding it down in July, they dusted off the printing press and cranked it back up in August!

And shortly thereafter, the Fed wrapped up its meeting on monetary policy by giving guidance that it would be ending its quantitative easing program. In fact, recent comments by Fed officials suggest that some areas of the plan could even end sooner.

Now, the outright purchases of government debt planned by both central banks are around $300 billion. As a percentage of GDP, that makes the UK’s purchases close to four times as large as the U.S.’s.

The diverging policy paths by the Fed and the Bank of England have created an ideal profit opportunity.

This development makes for a very compelling trade in the British pound …

You see, in currencies, it’s all relative. And on a relative basis, the diverging policy paths by the Fed and the Bank of England are squarely negative for the pound against the dollar. And that’s precisely why the pound has taken its lumps over the past month, down 4 percent against the dollar from its high in August.

Don’t forget, the British pound was punished when risk aversion swept through financial markets and has benefited as risk appetite returned. So adding the influence from divergent monetary policy paths to the “high” uncertainty surrounding global economic recoveries creates two negative drags for the British pound.

All of this puts the British pound in a position of weakness and offers currency traders an ideal profit opportunity.

Regards,

Bryan

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