Surprisingly Strong U.K. GDP Tests British Pound's Downtrend

Includes: FXB
by: Dr. Duru

The British pound was falling fast going into last week's GDP number. The pound even broke through support at its 50-day moving average (DMA). It seemed like momentum was setting up for a major disappointment until the GDP printed with 1.0% quarter-over-quarter growth, stronger than the 0.6% growth expected. GDP came in flat year-over-year whereas consensus expected a contraction of -0.5%. This better-than-expected performance set the pound soaring last Thursday (October 25th) as a follow-through to a bounce from six-week lows.

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GDP sends the pound soaring against the U.S. dollar but the short-term downtrend holds

The pound's strength has not yet sent it through the current short-term downtrend. I am expecting this downtrend to hold, so I remain short GBP/USD for now. Even if the downtrend breaks, I will be slow to revert to a neutral or even bullish stance because the longer-term trend is still working against the pound at these levels. The chart below shows a longer-term picture.

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A wedge is forming on GBP/USD


Interestingly, a wedge seems to be forming on GBP/USD. I drew the former uptrend from the panic lows to emphasize that the last big bounce in GBP/USD was essentially another successful test of the bottom of that wedge. The first successful test occurred in mid-January of this year. Given the current trading pace on GBP/USD, it may take many more months for this wedge to get resolution (to the upside or downside). In the meantime, bullish/bearish calls will necessarily carry a lot of fragility.

What keeps me bearish on GBP/USD at these levels is that the growth patterns between the U.S. and the UK are still working out in favor of the U.S. The commentary from various economists reacting to the GDP number is very instructive for me.

It seems very possible that the third quarter was surprisingly strong simply because economists under-estimated the positive impact of the Olympics and/or over-estimated the negative impact of the Queen's Diamond Jubilee. The GDP reading for the fourth quarter should more accurately depict the true direction of the economy. The more pessimistic economists think Q4 will show stagnation again. One economist suggested that the recent rise in the pound will sufficiently worry the Monetary Policy Committee (NYSE:MPC) to add more quantitative easing in November. With the Federal Reserve rolling out QE3, I think the MPC will be biased for action, especially if it concludes that more easing might support any momentum from the third quarter. In the meantime, traders should expect the pound to continue its tendencies to swing suddenly and sharply on an intra-day basis in either direction.

Be careful out there!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In forex, I am short GBP/USD