Today I’m going to look at sterling. Specifically, I’m going to look at the pound against the dollar – ‘cable’, to use the City jargon.
In my view, it’s reached a pivotal price point. And it’s reached that point just as several electoral events – some of them major – are lining up in the months ahead.
The outcome of those events could influence the direction of sterling in a big way, which, in turn, will affect many areas of our economy.
What’s more, there might be some money to be made…
The pound is near a historically important level
Last week, amidst all the celebration at our great economic recovery, sterling made a five-year high against the US dollar, touching $1.70. It’s since retreated a couple of cents.
The broad long-term pattern is: sell sterling at around two dollars, and buy it at $1.40. But there has always been a wall at $1.70. Historically, it’s been an important level.
In the 1990s it was resistance. In the 2000s, it was support. Since 2009, it’s been resistance again.
This first chart below shows cable since 1993. Ignore the “sell sterling at $2” and the “buy sterling at $1.40”. What concerns us today is the amber wall around $1.70.
You can see how, in the 1990s, sterling tried and tried to get through that wall. It gave up, then eventually fell along with the dotcom crash to $1.40 – or just below.
Post-crash, sterling had a huge rally, tested that amber wall at $1.70 just once, before racing through to $1.95. It came back to that wall, where it found support. Then it shot up to the heady heights of $2.10 by 2007.
Then the stock market crashed and so did sterling – by almost 35%.
It’s always the way. Whither the stock market, thither sterling. Sterling represents a financial-asset-based economy.
The trade here looks pretty obvious – and there’s no need to take a position right away. If sterling breaks above $1.70, it’ll probably go above $1.90, towards the $2 mark. If it sells off – perhaps in reaction to some electoral event – we could well be making our way back to the $1.50 area, and even below.
Either side of the amber line is a good place to put a stop. Above it if you’re bearish, and below if you’re bullish.
Which should you be? Well, let’s take a look at what could affect the pound in the next few months.
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How politics could affect sterling in the rest of the year
In terms of political events that could have a big impact on sterling, we’ve a busy calendar ahead. Next week we have the European elections and the local council elections. Recent polls show Labour to be weak, the Tories to be strong and also Ukip to be strong.
The surprise package is Ukip. Nobody knows how well they’re going to do. Nigel Farage is good box office and he gets his party a lot of publicity. But judging by some of the vindictive copy I’ve been reading, and from the smearing he gets on social media, he’s a ‘Marmite’ politician: he’s loved or loathed.
I would have thought sterling bulls would prefer to see us more out of Europe, (politically and administratively, at least), than in. So they might be hoping for a strong Ukip showing. But at the same time, a really strong showing might lead to fears of politically instability with the general election only a year away.
There are some who think that next week’s election is a big yawn, and I can sympathise with that. But it will tell us something about what is in people’s minds for next year.
It may also influence the outcome of what I think is ‘the big kahuna’.
The fate of the Union and the impact on the pound
That big kahuna is, of course, the Scottish referendum on 18 September. At present, it looks as though the Scots are going to choke (did I just say that?) and vote to stay in the Union.
But the meme doing the rounds is that Alex Salmond has a proven record of strong finishes in an election cycle. So that final vote might be closer than the polls suggest.
What will sterling’s reaction be if the Scots vote to stay in? Will it rally in relief at ongoing political stability? Or will it sell off at the prospect of no cut in spending obligations (for the rest of the UK)?
And, what if the Scots vote out? Will the pound rally at the prospect of lower spending obligations? Will it sell off at the prospect of political upheaval? And will it rally or fall at the prospect of a Tory government in England for the foresee-able future?
After Scotland, of course, we have the General Election next May. But that will not be on forex traders’ minds – not yet anyway.
And what’s in store for the US dollar?
Clearly, the outcome of elections is an unknown. But what about the other side of the coin – the US dollar?
While sterling follows the stock market, the dollar tends to do the opposite. People buy US dollars when they’re selling stocks, and sell dollars to buy stocks. That’s just a general comment – it’s not always the case.
You can see my thoughts on the dollar from last week here. But broadly speaking, the dollar has been flat for three years now, so I get the feeling it’s warming up for a move.
I’ve also got a feeling that the trend for the dollar, after a wobbly summer, might be up – which would suggest sterling’s rally fizzling out at $1.70. But we shall see. Perhaps US monetary policy won’t tighten.
However, one thing I would flag up is that I came across this survey of sentiment on the US dollar this week – and it is approaching extremes. The red dotted line represents extreme bullishness, and the green dotted line shows bearishness. (The idea is that you buy at points of extreme bearishness and sell at points of bullishness.)
Sterling may well break above the amber wall, depending on what happens. And I’ll be watching closely to act if it does. And it’s possible for the dollar and sterling to both be strong. For example, the euro may tumble against both of them if markets start to believe that European Central Bank governor Mario Draghi is finally serious about doing “whatever it takes”.
But I have to say that, based on sentiment alone, I would not be selling US dollars here.
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