In early March 2021, I suggested that Sterling was due a correction from its peak of $1.42; it fell to a low point of $1.3670, but then resumed its up-trend to re-test the highs of late-February.
As is often the case, the new peak was only a fraction above the $1.4242 previous high, trading briefly at $1.4249, before falling over a cent in one day.
This “failed break-out” serves to clear out the last short positions, as stop losses are commonly placed just above the previous highs of a recent trend, in what is referred to as “stop hunting”. Once these shorts have been cleared, the way is set for the downtrend to resume.
The next few days will be important in deciding whether the one year long Sterling bull market is now over.
US Dollar sentiment is still extremely fragile, and the Pound has benefitted from the perception of success in the vaccine rollout.
But as economic data begins to improve globally, attention will now turn to the prospects for tapering (reduction) in Central Bank bond buying.
In order to be successful, it will have to be globally co-ordinated (or one Bank will be left with a soaring currency and none of them have shown any appetite for that!).
As foreign exchange is a zero-sum game, one currency will have rise for another to fall,
the question is who has the most to lose from a rising currency?
Export dependent nations (such as Japan and Europe) will most likely put up the most resistance, but for the UK and the US, it is not so critical- indeed, with both UK and US inflation numbers showing a large rise in April, the pressure is on them to normalise their economies sooner, at first by reducing QE amounts and later on, maybe even raising interest rates.
The ultimate question is, faced with a choice of allowing higher inflation, higher interest rates or a higher Dollar, which will the Fed choose?
Given their overwhelming desire to protect their stock markets, the first two may not be an acceptable option.
A higher Dollar would help to contain inflation (thus reducing the need for large hikes in interest rates) if the current relationship (below) between Inflation and the US Dollar movements is maintained and so this appears the least bad option for them to take.
FX options provide a cheap (and low risk) entry point via September $1.39 puts, which currently trade around 7.1% implied volatility.
Trading at around 101, a move back to the $1.40 level in the next two weeks would imply a price of around 150.
Stop losses would be triggered by a move above the $1.425 level on a closing basis, which would mean a selling price of around 75, should the Pound resume its rise.
Read more about GBP/USD trading.
