Early Tuesday morning, news that the UK economy shrunk by 0.5% during Q4 of 2010 sent Cable reeling. Expectations were for a growth rate of 0.4%. The worst winter weather in a century is to blame. Even without inclement weather hitting the retail and service heavy economy, growth might have still come in flat. Take slow (negative) growth and throw in an uncomfortable rise in inflation --reaching an annual rate of 3.7% in December -- and you have a recipe for stagflation. In the weeks prior, traders were snatching up Sterling vs. the Dollar as risk to the upside in interest rates appeared to be present, and with Bernanke's easy -- very easy -- monetary stance, it was a thesis to be bought into.
Last night, the BOE minutes from January's meeting were released indicating a slight increase in hawkishness as the committee shifted ever so slightly in favor of a rate hike later this year. A rate hike from the current benchmark rate of 0.5% will still keep monetary policy highly accommodating and the interest rate differential between the U.S. and UK will remain quite narrow. This week's surprise in growth numbers was reason to give pause to the notion of higher rates, and that is exactly what happened Tuesday as the GBPUSD shed over 200 pips at its worst levels. While the report could be a weather related abberation, we will still need to keep a close eye on further signs of economic deceleration as growth is still quite tepid even when the sun is shining.
From a technical perspective Sterling is at an important crossroads with two significant long-term trend-lines intersecting recent highs on the weekly chart. One passing down from peaks made in '07, '08, and '10. The other trend-line connects two peaks made in '09 and one in '10. Adding even further bearish implications are two technical developments. A head-and-shoulders pattern near completion within a longer-term 4th-wave triangle. If the H&S pattern comes to pass, then it would be the turning point for the C-wave of an A-E triangle which will end in a sharp move lower, completing the trend which began in late 2007.
Could this set-up be a perfect storm of fundamentals and technicals converging to tell the same story? I will be looking for entry points to sell short, maybe as soon as this week.
Later today the FOMC is expected to leave rates alone, but, it will be their statement, as per usual, that will move markets. Since the crisis the Fed has become increasingly transparent taking away the shock factor. However, should Ben and Co. hint at taking their foot off the LSAP gas pedal then it could spark a strong broad based rally in the Dollar. This shouldn't come as a surprise given the recent improvements in economic data, strong rise in equity prices since the speech in Jackson Hole, and fears over inflation and the ever climbing commodity sector. Upward global pricing pressure has inflation rates in most corners of the globe -- from China to India to South America to the UK -- climbing into uncomfortable territory.
Ahead of the meeting I am not inclined to take on additional risk, as I currently have bearish bets on in AUDUSD and Copper. I took profit in the precious metal shorts as bullish sentiment and momentum indicators have receded back to levels seen at the lows in July of 2010. (Gold still has room down to 1280-1300 if it can break support around 1320.) Furthermore, there is a fairly high degree of positive correlation between precious metals and the Australian Dollar (currently my most substantial position).Disclosure: Short AUDUSD, March Copper.