The British pound is the only currency to fall against the US dollar today, leading many traders to wonder why we are seeing such severe underperformance in the currency. The simple answer would be deteriorating UK fundamentals, but a closer look at different relationships in the financial markets reveal otherwise.
The biggest loser in the currency market today is GBP/JPY which has fallen over 600 pips. USD/JPY is also down 2 percent, which is the largest drop in the currency pair on a percentage basis since the subprime debacle hit its peak on August 16th. It is clear that GBP/JPY selling is a major reason why the British pound is unable to rally against the US dollar like the Euro, Australian and New Zealand dollars have. The relationship between the British pound and oil prices is also breaking down and when this happens, there tends to be sharp movements in the GBP/USD.
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Don’t Underestimate the Power of GBP/JPY
The biggest story of the day is the market’s appetite for risk. The Dow is down close to 200 points and even though we have seen moves of this magnitude in the past few months, they have not led to the degree of weakness in the Yen crosses that we have seen today. Carry trade liquidation is in full force and this has caused GBP/JPY selling to impact the price action of the GBP/USD. Typically the majors have a bigger influence on the crosses, but when it comes to GBP/JPY, there is so much volume in the pair that we often see the reverse. According to the following pie chart of the volume on FXCM mini servers from June 2006 to November 2007, GBP/JPY is the third most actively traded currency pair next to the EUR/USD and GBP/USD. On a day to day basis, we have even seen GBP/JPY capture the number one title from the EUR/USD. In fact, GBP/JPY sees 3 times the volume of any the commodity currency.
The next chart illustrates the correlation between GBP/JPY and the GBP/USD. As you can see, there are times when the moves in GBP/JPY (blue line) precede the moves in the GBP/USD (red line). What does this tell you as a trader? That if we get more dollar negative numbers such as this morning’s manufacturing ISM report, we may finally see a bounce in the GBP/USD.
British Pound: What to Expect Next?
Technically we are looking for further losses. In our GBP/USD 2008 forecasts, Jamie Saettele said that the currency pair has recently broken below the channel that had remained intact since May of 2006 as well as the 200 day SMA (currently just above 2.0150). These developments warn of a significant trend change. Near term, the pattern is not especially clear but we do expect a drop below 1.9755 and possibly a test of the 161.8% extension of 2.1160-2.0353/2.0831 at 1.9525 before a bounce. That bounce will clarify the overall pattern and provide us with our bias for months. If the rally is an impulse, then we will get bullish against the registered low. If that rally is a correction in wave 4, then we will expect the decline to continue in wave 5. The bearish count is what we are showing on the chart.
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