 U.K.'s pound sterling at a consolidation crossroads
by Kevin Pendley
As I write this FX column, the Open Championship for golf is underway in merry old England. It's mid-July, and spectators are huddled like sheep into the hills, trying to avoid snarling winds, sideways rain and brutal conditions. Is it any wonder that the Brits became one of the greatest sailing forces on the planet? Who wouldn't want to escape that dreary island and see some of the world? I just pity the British citizens who drew the short straw and didn't relocate to the Caribbean. And how about sending your prisoners to Australia — who says crime doesn't pay off!
You would also think after establishing the greatest empire in history, one in which "the sun never sits," they would have imported some decent cuisine, but whenever I've been in the United Kingdom, pub grub was about the only edible food I could find. Ah, but I digress … just what does the U.K. foreign exchange picture look like right now?
We've become familiar with troubling economic news here in the United States, but how are things on the other side of the pond? Here is a sample of headlines from just the last few days out of England:
• "U.K. jobless claims post biggest rise since '92"
• "U.K. inflation surges, economic gloom deepens"
• "U.K. factory gate inflation at double digits"
• "U.K. housing downturn could cost 100,000 jobs"
• "U.K. house prices fall, homebuilders feel pain"
• "U.K. firms cash flow weakest in 16 years"
• "U.K. recession fears grow as output slides"
• "U.K. recession alarm rings amid services slowdown"
You get the point. The economic picture in England is every bit as gloomy as the weather at the British Open golf championship. What does that mean for the pound sterling FX market? The euro/sterling cross soared to record highs back in April, culminating a dramatic run that saw the euro appreciate a stunning 23.8% against the U.K.'s pound sterling from the January 2007 low of 0.6356 to the April 2008 peak at 0.8098.
The euro/sterling cross has recently pulled back to about 0.7920 and continues to struggle to sustain rallies toward 0.8000. The cross has been in a consolidation mode for the last three months and should be sitting on a breakout move, the only question is which direction.
As we've noted in previous columns, the "trend is your friend" is a valuable rule of thumb in foreign exchange markets as currency markets tend to drift along with macro-economic developments and investment patterns that play out over a long period of time. Since the euro/sterling has been on a long-term upward draft, then the odds favor an upside resolution of this sideways consolidation. However, as you've seen in this column in previous weeks, I tend to lean toward a contrarian sentiment at this stage of the global economic cycle (except when it comes to demand for physical goods).
I've been shorting the euro against various currencies since April with uneven success, and even though the euro made new highs against the U.S. dollar this week, I still prefer finding spots to short the euro, and I lean that way on the sterling cross as well. One nice thing about the chart patterns in play right now is that risk is well-defined on short euro/sterling trades. If I'm wrong about the euro top emerging soon, it won't cost much, but if I'm right, then the pullback should be quite rewarding.
Updating our current trade recommendations, our short euro/dollar trade and short Aussie trade were stopped out last week. But I'm willing to get right back on that familiar bucking horse and give it a go again on the euro shorts. After all, when the euro made new all-time highs this week, it immediately collapsed off those levels, leaving a bearish reversal visible on the charts!
FX COLUMN TRADE CONCEPT RECAP
DATE CONCEPT PRICE THEN/NOW PROFIT/LOSS COMMENT
4/24/08 Short euro/dollar entered @ 1.5682 +0.52% stopped out at 1.5600
5/01/08 Short euro/yen entered @ 161.50 +0.12% stopped out at 161.30
5/08/08 Short euro/Canada entered @ 1.5680 +1.46% profit taken @ 1.5450
5/15/08 Short euro/yen entered @ 162.40 -0.36% stopped out at 163.01
5/29/08 Short euro/dollar entered @ 1.5525 -0.55% stopped out at 1.5610
6/10/08 Short euro/dollar entered @ 1.5682 +0.99% stopped out @ 1.5610
6/19/08 Short Aussie/dollar entered @ 0.9600 -0.49% stopped out @ 0.9670
7/03/08 Short euro/dollar entered @ 1.5750 -0.64% stopped out @ 1.5851
7/18/08 Short euro/dollar entered @ 1.5885 n/a stops @ 1.5951
7/18/08 Short euro/sterling entered @ 0.7920 n/a stops @ 0.7981
Kevin Pendley has been involved in financial and commodity markets for two decades, including more than 15 years with Knight-Ridder Financial News/BridgeNews. In addition to his work at 4xAdviser.com Weekly, he is a contributor at SmallCapInvestor.com where he writes a weekly technical analysis column on the Russell 2000.
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