It’ll be interesting to see how Sterling fares against the dollar in the next couple weeks. After a sharp drop against the dollar in the fall, Sterling has rallied in May (see chart below). Sterling is currently at a critical point. There are two technical indicators traders will be watching closely. First, there is a support/resistance level at around 1.62 GBP/USD. Second, the 200 day moving average is set to cross the 50 day moving average soon. (It is a sign of upward momentum when a short term average crosses above a long term average.) Therefore, if Sterling continues its rally over the next week it is a good sign the strength of Sterling is sustainable.
Fundamental factors also make this an interesting time. First, the rally comes after UK Chancellor of the Exchequer Alistair Darling revealed a controversial budget that forecast high debt until 2018. The FT described it as a “gamble on a rapid economic recovery and severe spending cuts.” Second, S&P downgraded the UK’s outlook from stable to negative this Thursday. The market responded to this news with a strong sell-off; however, by the next day Sterling was higher than before the news. Fundamentally, Sterling should have fallen more than it did. The reason it didn’t give up its gains is Sterling is in the middle of a broader realignment against the dollar.
The Pound/Dollar example is important to watch because it is a demonstration of the strength of the currency market’s attempt to return to normalcy. Precipitated by the fall of Lehman Brothers, most currencies fell heavily against the dollar during fall 2008. The common consensus was that the dollar was a safe haven during perilous times, though some, like billionaire Jim Rogers (who is very bearish on the US economy, government, and dollar), argued the rise in the dollar came from currency speculators covering their shorts. Either way, as the idea of green shoots has become more widespread, the dollar has fallen in value. One metric to measure this is the CBOE volatility index (the Vix), which has risen and fallen with the dollar. It is not coincidence that Sterling rebounded from the S&P downgrade in the same week the Vix broke 30.
The current return to normalcy was attempted earlier this year in January, though gains in the euro, pound, and yen were quickly eliminated after further negative economic news. This return to normalcy has been a trend in many other asset classes as well. It will continue as further (relatively) positive economic data gives way to gains of hemorrhaged assets like the pound, the euro, corporate debt, and oil.
