Cable has been trending lower this week, despite inflation coming in hotter than expected. That unusual situation is an illustration of how multiple factors can influence the performance of the forex market. In this case, diverging economic outlooks are overcoming short-term economic data. The other factor is the rise of the Footsie.
The leading stock index in the UK has scored three consecutive record highs over the course of this week. This has put it at odds with other indices that have been treading water ahead of the Jackson Hole Symposium. Normally, when the stock market rises, the currency declines. So far, that seems to be playing out with the GBPUSD. But that doesn’t meant it will stay that way.
Why is the FTSE 100 Outperforming?
The reason we should pay attention to UK stocks when trading the pound is capital flows. The value of currencies fluctuate depending on demand to buy assets in those currencies. This is why the dollar has underperformed over the last eight months despite the Fed not cutting rates. Investors were selling dollar-denominated assets, in favor of mostly European stocks which have been rising.
If British stocks were expected to rise substantially, then the pound would be expected to strengthen. That’s because in order to buy UK stocks, foreign investors must first buy pounds. What some analysts have been pointing to is the rising FTSE has coincided with a drop in US tech stocks. That’s a sign that investors might be getting tired of the AI-backed run in high valuation tech stocks, and buying UK defensive firms that have relatively low valuations.
Will the Trend Continue?
Over the last week, markets have been pricing in the risk that the Fed will not cut rates in September. That has had two main effects. The first is the dollar getting stronger on the back of higher debt yields. This has contributed to the GBPUSD declining.
The second is that higher interest rates typically make it harder for stocks with high valuations to make headway. Most US tech stock shave really high valuations. That’s because investors are buying into those companies expecting them to grow in the future. But, if the central bank leaves rates higher, then the economy won’t grow so fast, making it more difficult for companies to expand and increase profits.
It’s Still a Matter of Interst Rates
Higher interest rates means it’s not such a good investment to speculate on growth stocks. Companies that are trying to grow fast pay little or no dividend. Which means traders rely on the stock price increasing to make money. This investing in something that isn’t providing a regular return on investment is much less attractive when interest rates are higher.
In other words, if the Fed doesn’t deliver on expectations for rate cuts, then the trend for investing in the FTSE might continue. Which means that, aside from some short-term fluctuations like last week, the dollar could resume its weakening trend. Coupled with increased demand for British stocks, the pound could get a boost. Especially now that the market expects the BOE to keep rates steady for the rest of the year.
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