Forex Trading Ideas: Is Sterling About To Get Pounded?

Fundamentals

They used to say that the sun never sets on the British Empire, as Great Britain was the dominant economic power in the world prior to World War II. Now, however, the Pound Sterling has fallen on hard times, as traders fear record budget deficits and continued policies of low interest rates will weigh heavily on the nation’s currency. On Thursday, it was announced that Britain ran a budget deficit of 11.4 billion Pounds in October, which was the largest monthly deficit since records began in 1993. The recent recession has hit Britain hard, sending unemployment rates soaring. The Bank of England, taking its cue from the U.S Federal Reserve, embarked on its own quantitative easing policy in order to provide stimulus to its struggling economy. In addition, the Bank of England (BOE) has lowered it key interest rate to 0.5%. This low interest rate is not expected to be increased any time soon, despite some glimmers of economic improvements in the world economy. On Thursday, the Organization for Economic Cooperation and Development (OECD) in its Economic Outlook does not expect significant improvements in employment and resource utilization until 2011, at which time the OECD expects the BOE to begin to ease its accommodative interest rate policy. Since it appears that the BOE will not be raising rates anytime soon, traders may begin to look towards the Pound as another funding currency for so called “carry-trades.” In a “carry-trade”, a trader will borrow (sell) a low interest rate currency such as the Japanese Yen, U.S. Dollar — and now the British Pound — and invest (buy) a higher rate currency, such as the Australian Dollar or Brazilian Real. If economic growth rates in Great Britain continue to lag behind those of other OECD countries, then there is a good chance that traders will continue to add to “carry-trades” vs. the Pound, and keep steady selling pressure on the currency for some time to come.

Trading Ideas

Currencies are notorious for large overnight moves, especially when economic reports are released. Although the fundamentals do seem to favor continued pressure on the British Pound, it may be difficult for some traders to hold positions through periods of large price moves. Utilizing long option strategies on British Pound futures options is one way traders can help define their risk while being able to hold a position through volatile trading conditions. One such trade is buying bear put spreads in the British Pound. An example of this type of trade is buying the January 1.63 puts and selling the January 1.56 puts. With March British Pounds trading at 1.6510 as of this writing, the put spread could be purchased for 1.63 points, or $1,018.75, not including commissions. The premium paid is the maximum risk on the trade, with a potential profit of $4,375 minus the premium paid should March Pounds be trading below 1.5600 at option expiration in January.

Technicals

Looking at a daily continuation chart for British Pound futures, we notice prices have moved into a rather large consolidation pattern (13 full points) since the beginning of June. The recent rally attempt to test resistance near the 1.7050 area was met with fresh selling, and the December futures were unable to trade even above 1.6900. The 20 and 100-day moving averages are starting to converge near the current market price, which is a hallmark of a market that continues to be range bound. The 14-day RSI has moved into neutral territory, with a current reading of 50.00. Major support is found at the lows of the recent consolidation near 1.5700, with resistance seen at the recent highs near 1.7050.

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