Currency markets have been somewhat shortsighted of late, as most of the attention remains firmly focused on the U.S. dollar and the potential changes in trend direction that could be seen if the Federal Reserve. But the broader uncertainty that is generated by the stimulus guessing game leaves the greenback vulnerable to unpredictable price swings that do not lend themselves to high-probability investment decisions. Instead, it makes sense to look for less commonly traded alternatives and play things from the short side. One of the most attractive contrarian opportunities at this stage of the game can be seen in assets tied to the British pound, as broader GDP growth performance in the U.K. still lags well behind what is seen in the U.S.
One ETF to watch is the CurrencyShares British Pound Sterling Trust (FXB), which is back trading near its yearly highs above 160. The British pound itself has gained nearly 3.5% in the last month alone, but when we take a step back and look at the broader fundamental picture there are some reasons to believe all of this strength is unwarranted. On the positive side, we can see there are substantial improvements in consumer confidence surveys and in mortgage applications (which rose to 68,500 in October). This has led the Bank of England (BOE) to publicly announce its intention to limit its Funding for Lending Scheme (FLS) in 2014 so that the program will no longer be available for home loans, and instead will focus solely on expansionary opportunities for businesses.
This ultimately implies that the BoE is concerned about the prospects for a housing bubble in the U.K., but the most direct impact thus far has been seen in the value of the pound itself, which quickly surged above $1.63. So, the real question here is whether or not market valuations are truly supported by economic fundamentals or are simply being driven by knee-jerk reactions to central bank commentary and potential changes in stimulus programs. Most of the evidence, however, points to the latter. The pound is now trading at its highest levels since January (up 7.2% in the last six months), but this latest rally should be flashing signs of caution for those looking to hold long-term buy positions in assets tied to the currency.
The main problem is that this withdrawal of stimulus at the BoE has yet to be confirmed by real growth rates, which remains tepid at 0.8%. it should also be remembered that the U.K. economy has only recently started to show signs of stabilization after nearly falling into a recession last year. Recent statements from BoE Governor Mark Carney have even gone so far as to suggest that the U.K. is now the world's best-performing developed market economy. But it does not take much research to see that the numbers simply do not confirm this assertion.
The real growth surprise this year has been seen in the U.S. economy, which is now posting GDP rates well above the market's recent expectations. Less optimistic, however, have been recent central bank commentaries relative to the need for additional stimulus. There is a fundamental disconnect here between what is being voiced at the central banks in both regions and in the underlying growth figures. Until this changes, any rallies in FXB should be viewed as a selling opportunity as they are likely to underperform assets tied to the U.S. dollar, like the PowerShares DB US Dollar Index Bullish ETF (UUP).
Chart Perspective: FXB
Upside momentum in FXB has been undeniable for most of this month. But for those with more of a contrarian outlook, this suggests a significant need for markets to return to their historical averages. Given the warning signs seen in the fundamental backdrop, investors should begin looking at prices themselves to begin seeing indications that the latest rally has run its course. Important resistance levels can be found at 161.30, which is already a triple top. Any failures here will likely lead many FXB bulls to jump ship and take profits, sending prices much lower.