British Bound Diverges from Risk Trends as Growth Outlook Becomes Driver

http://www.dailyfx.com/forex/fundamental/article/drivers_of_price_action/2011/01/04/British_Bound_Diverges_from_Risk_Trends_as_Growth_Outlook_Becomes_Driver.html

Drivers Of Price Action

British Bound Diverges from Risk Trends as Growth Outlook Becomes Driver

GBP/USD

The GBP/USD rose sharply following a robust manufacturing report but failed to break from its bearish trend as the pound has been under pressure on the back of a dimming growth outlook. The December PMI reading improved to 58.3 from 57.5, besting expectations for a decline to 57.2 and reaching the highest level in 16 years. We have started to see yield expectations grow in importance in determining direction for the pair with its correlation rising to 32%, putting a greater focus on U.K. fundamentals. Meanwhile, risk trends have started to lose influence as we see broader markets begin to decouple. Stock prices and the pair have diverged in recent weeks with equity markets now explaining 49% of price movement compared with 60% a month ago. A declining trend line is providing resistance near 1.5640 with former congestion and the 200-Day SMA generating support at 1.5350/400, a break of either could create a medium term opportunity.

Driver of Price Action	Current Influence	Correlation	Week Ago	Month Ago
GBP Interest Rate Expectations	Medium	0.32	0.35	0.30
USD Interest Rate Expectations	Low	0.09	0.01	-0.05
Risk (Dow)	High	0.49	0.52	0.60

BoE Interest Rate Expectations

U.K. interest rate expectations have been on the decline heading into the New Year with an increase in the VAT scheduled to take hold. The stricter austerity measures from the new government are expected to slow growth in the island nation and have been a weighing factor for the pound. Overnight Index Swaps are now pricing in 34 bps of tightening over the next year down from 44 bps on December 15th. However, strong fundamentals and rising inflation have increased the chances of a hawkish monetary policy, which could limit downside risks for the GBP/USD. Indeed, an unexpected rise in mortgage approvals was welcomed surprise for policy makers which have expressed concerns that tight lending standards could keep home prices depressed. A weaker net consumer credit report is a concern in the face of rising costs for goods which could keep the MPC sidelines for the foreseeable future. If we get through the first part of the year without a change in the BoE’s stance then downside risks could significantly increase, if growth starts to fade. Discuss this and trading ideas join the GBP/USD forum.

Credit Suisse (OIS) BoE

Source Bloomberg – Prepared by John Rivera

FOMC Interest Rate Expectations

Core U.S. inflation at 0.8% and expected to have maintained that level of price growth in December has begun to weigh on yield expectations. The FOMC is forecasted to remain on hold through at least the first half of 2011 and well beyond, unless we start to see a sharp rise in consumer prices or a spike in hiring. The upcoming Non-farm payroll report could help make a hawkish case with employers predicted to have added 140,000 new workers in December. However, one month of gains would only be a starting point and until we see a consistent trend of hiring, policy makers will maintain their dovish stance, potentially limiting greenback support.

Source Bloomberg – Prepared by John Rivera

Risk

A sharp sell-off in commodities weighed on equity markets in early trading but stocks were able to regain their footing. A somewhat positive tone to the FOMC minutes is helping keep bears away as the pair continues to trade above its rising trend line. Expectations for a strong labor report at the end of the week could keep support firm. However, further decline s in raw material prices and a break below trend line support exposes downside risks. Discuss this and other fundamental data in the Economics Forum.

Dow (10 Mins)

Source Bloomberg – Prepared by John Rivera

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com

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