The British pound (GBP/USD) is becoming one of the biggest movers in the forex markets, propelled in large part by the stronger U.K. GDP figures seen this week. This is supportive of ETFs like the Betashares British Pound ETF (ASX:POU) and the Currency Shares British Pound Sterling Trust (FXB), and these trends look set to continue. The GDP data showed that economic growth in the U.K. improved by 0.3% on a quarterly basis, and this creates a yearly increase of 0.6% for the economy. This is the best performance since the end of 2011, and the GBP/USD has rallied through some important price levels after the release.
At this stage, we are looking at a test of 1.55 as the U.S. dollar continues to lose ground against most of its major counterparts and general risk sentiment continues to improve on higher earnings. When dealing with currency markets, it is important to look at the strong correlations that exist between non-U.S. dollar denominated currencies and the major stock exchanges. Given the heavy corporate earnings calendar that we have seen in the last two weeks, these two markets will inevitably influence each other in substantial ways.
BoE Critiques and Currency Values
The stronger GDP figures will take some of the pressure off of the Bank of England (BoE), which has been widely criticized for its inability to initiate quantitative easing programs that are positively influencing the broader economy. Most of the recent actions from the BoE have led to credit downgrades and a loss of the AAA credit rating in the U.K. Improvements in GDP will help to support the credibility of the BoE's long-term plans, and this will also support the British currency over the long term. From a price perspective, traders seem to be agreeing with these prospects, as prices are now forcing themselves through important Fibonacci resistance levels derived from the yearly declines in the GBP/USD. This essentially suggests that this decline is coming to an end, and that a longer-term rally is imminent:
Click to enlarge images.
Correlated Assets and the Major Indices
Another important factor to consider is when assessing the future values of the GBP/USD is the behavior or correlated assets. Most forex traders will point to the EUR/USD, and the Currency Shares Euro Trust (FXE) and ProShares UltraShort Euro ETF (EUO) when looking for highly correlated assets. There is a great deal of truth to this because strength or weakness in the U.S. dollar will affect both the euro and the British pound in similar ways. The rebounds that are being seen in the British pound are also being seen in the euro, and this essentially suggests that we have seen a long-term bottom in both the EUR/USD and the GBP/USD.
But it is important to watch other correlated assets as well. Any suggestions that we will see an end to the BoE's quantitative easing program will be bullish for the GBP and bearish for the FTSE 100 stock index (as the two show an inverse correlation when quantitative easing changes). Valuations in the FTSE 100 and HSBC FTSE 100 ETF (EPA:UKX) have shown evidence of a rally but when compared to near-term averages, these rallies in the FTSE 100 look to be rolling over and coming to an end:
Other examples can be found in the S&P 500 and the SPDR S&P 500 ETF Trust (SPY), which are used as a broad gauge of investor sentiment. Both experience important correlations with high yielding currencies, the GBP/USD and the EUR/USD. Most of the recent corporate earnings reports have been supportive of the S&P, as nearly 75% of the companies have reported results that have surpassed analyst expectations. Positive momentum here is suggestive of another run at the all-time highs:
The most recent example of individual stock performance that will be supportive of the U.S. stock indices is the strong rally in Ford (F), which is another example of staple stock that is showing improved first-quarter earnings and strong price momentum:
These types of stories will continue to work in conjunction with one another. Continued strength in individual earnings from staple companies will support the broader indices. The high correlation values between these indices and the GBP will guide the overall bias of forex traders. As long as macro data and the corporate earnings pictures remain supportive, expect future gains in the GBP/USD.
About the author:
Trade ideas are generally based on time horizons of one to six months.
Follow me on Twitter: @Richard_A_Cox