The pound is looking promising – against one major currency in particular

I haven’t covered sterling for a while – partly because I don’t want to jinx it – but I can ignore it no longer. Today we look at the British pound. It is having a good year.

We will start with its performance against the dollar and the euro. But it is the pound against the Japanese yen that I am really interested in. I’ve been studying the price action since the 1990s, and there is quite an exciting observation that I would like to share with you.

The pound has had a solid run, and it looks set to continue 

The standard benchmark by which we look at the pound is “cable” – the pound versus the US dollar – so-called after the first transatlantic cables were laid under the Atlantic in the 1860s, enabling the London and New York exchanges to reliably and quickly relay currency prices (one tends to forget the role that communication technology has played in the evolution of money).

Having begun 2021 at $1.35, cable hit a high of $1.42 late last month. But dollar strength of late has seen the pound slide back to $1.39. This is a bull market that began last March, and the recent action seems to be a fairly standard pullback from overbought levels. Historically however, that zone – a couple of cents either side of $1.40 – has been a pivot point of support and resistance, and it will probably be so again.

The pound has had a rip-roaring start to the year against the euro as well, going from €1.10 in January, to touching €1.17 this morning. Longer-term the bull market is not so clear cut, but I would hope to see this above €1.20 later in 2021, with all the usual forecast volatility along the way.

One issue I have with cable however, and to an extent the pound-euro exchange rate, is that forex (foreign exchange) pricing is greatly influenced by the actions taken by the central bank of the larger economic bloc. Utterances by the US Federal Reserve can have a greater effect on the cable price than utterances by the Bank of England. It’s not always the case, of course, but often.

As a result I have a fondness for pairs where relative GDP is closer. That brings me to the pound versus the Japanese yen. 

The pound could rise much further against the Japanese yen

Though not so dissimilar in terms of landmass, Japan’s population is roughly twice that of the UK (126 million compared to 63 million) and its GDP is around $5trn, when the UK’s is closer to $3trn. Nevertheless, it will do.

Despite the daily and weekly volatility of forex, in the longer term you will often see broader trends that can go on for many years – ride these and you can make a lot of money. This is very much the case for the pound against the yen.

Below I have posted a monthly pound-yen chart which goes back to 1990. In addition to the price in black, I have plotted the nine and 21-month moving averages in blue and red. These strip out the volatility and show you the broader trend. 

You can read about my moving average crosses system here. This is a simple trend-following system that removes the need for any kind of fundamental analysis. In fact, the less knowledge you have about the underlying markets, the better the system works. Your only care is the direction in which a market is trending.

The longer-term changes in trend can be marked by the moving average crosses – when the shorter-term moving average (in this case the nine-week) crosses through the longer-term MA. I have marked these changes in trend with black arrows. You can see that there have been only ten of these major trend changes since 1990 – on average, one every three years in other words. The pound-yen pair can trend for many years in one direction or the other.

From 1990 to 1996 the direction was down. From 96 to 98 it was up. The next three years were down. The bull market from 2000 to 2007 lasted seven years, then we got five years of bear market that took us to 2012. These are long, tradable cycles which mean you don’t have to get involved in daily noise. The four years from 2012 to 2016 saw another bear market. Two years of bull market followed, from 2016 to 2018, and two years of bear market from 2018 to 2020.

These signals are lagging indicators. They don’t mean “run out and buy as soon as you read this”. But they do serve to show you where we are in the grand scheme of things. Until 2016, these signals only occurred once every several years.

The point I want to make is that late in 2020 we got another of these crosses, marking another change in trend from bear to bull market. Look at the past and at how long these cycles can go on for, and you start to get quite excited about the possibilities.

Currently the pound sits at ¥151. It has had a bonanza run from late 2020, as it has against the dollar and the euro, no doubt because there is finally Brexit clarity. I see some resistance at the 2018 highs of ¥156. After that there is a fairly clear run to above ¥190, I’d say. 

We tend to have a low opinion of our country because of the endless flow of bad news our media pumps out. But other countries have exactly the same problem of self-esteem, and, perceived from abroad, the UK is not at all a bad place to be. Even after the run it’s had, the pound is only at its 2000 lows. There is a lot of potential upside. It’s not like the Bank of Japan isn’t printing.

So ¥150-¥156 is a resistance area, and I expect some range-trading here. But the short-term trend is up. And the monthly moving averages, as shown above, are signalling that the long-term trend has changed too.

Let’s see where we are in a couple of years.

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