Cable has been on an upward trajectory since the start of the year. The Rise of Cable has seen the pair gain over 300 pips in less than three months. While that initially sounds like quite a lot, we must factor in the other half of the currency pair: The dollar index is down 4.0% in the same period. In fact, it’s the worst performance for the greenback since 2009.
When arbitraging with other currencies, we find that the pound itself isn’t the explanation for the upside to cable. It has had its worst performance against the Euro in almost two years. What this rather implies is that if cable will rise, or it will top out now, will likely have more to do with external factors than what’s going on in the UK. But, that doesn’t mean we can entirely discount the British data. There are some factors that could rile up the markets from the British side as well.
Why the Big Moves
The main driver for major currency pairs since the start of the year, and especially the last couple of weeks, is weakness in the dollar, further fueling the Rise of Cable. The softer greenback has been caused by a precipitous drop in interest rates. Normally, major changes in interest rates are up to the central bank. But the perception of what the Fed will do has remained pretty much unchanged over the last month, barring a couple of short-term moves. The market is still pricing in rates staying steady until a cut in June.
What has been happening is a worry about a potential recession. This was first brought to the market’s attention when the Fed’s GDPNow tracker for Q1 economic growth crashed into negative at the end of February and stayed there. It is now projecting the US economy will show -2.4% growth this quarter. As a result of the economic concern, investors are piling into the safe haven of US treasuries, which has the effect of driving down yields. Lower yields means the currency gets weaker.
Why Hasn’t the Pound Kept Up?
So, it’s not a matter of the pound going up, but why the pound hasn’t gone up even more. The Euro, by comparison, has risen 5% in the same period. Part of that is the rising yields in European bonds, as investors worry about the ability of governments to pay back growing debts. With the EU promising unprecedented spending in defense, that debt is expected to increase, driving yields higher and dragging the Euro with it.
The UK has also promised to increase spending, but not by as much and it’s not expected to be a large burden on the country’s finances. As a result, UK yields have not risen at the same rate as those on the continent. And there is still worry that the British economy might underperform this year, which would keep the BOE on an easing trend.
What the Data Says
Friday sees the release of January UK GDP monthly growth figures, which are expected to show a declaration to 0.1% from the surprise 0.4% growth in December. What could hurt markets is if the prior month is revised lower, given its outlier status. The rolling three-month GDP growth rate is expected to remain elevated at 0.3% compared to 0.1% prior as the poor performance of last October rolls off.
What traders are likely to be looking for is a concrete sign for either of two options. The one that is good for the pound would be a continuation of December’s gains which would give the BOE room to stay more hawkish. Or a drop back to the slower growth levels that are forecasted by policymakers and justifying more easing from England’s central bank.
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