29th March - What is happening to Short Sterling?
30 March 2012
TECHNICALS:
WEEKLY CHART
The market has been stalling at the 99.00 level for a while since August 2011.
We have been tempted to call the top in the rally, by combining a this evident pause with interesting short-term patterns.
DAILY CHART
When we sent out the MU of the 22nd March we felt that the day chart showed a completed H&S Top.
That was assuming that ‘Possible Neckline 1’ was important.
As is clear, that Neckline failed.
The market rallied through it and stands much higher today.
Is the bear case smashed? In the short-term yes. But we remain impressed by the multiple failures at 99.00, and think that the odds remain in favour of another failure.
Note that another bear H&S Neckline remains possible, using a Double Headed H&S form, if the market fails from below say 99.10 or so.
FUNDAMENTALS:
Over recent weeks, indeed for much of the first quarter, UK data had turned firmer with the PMI Services survey in particular moving decisively above the crucial 50 level that defines growth from recession.
Even the PMI manufacturing survey, that represents a much smaller segment of the economy, had pointed to better conditions which was seen by some policy makers and politicians as a sign that the longed for rebalancing of the economy was finally taking place.
These developments led many analysts, traders and investors, including ourselves, to conclude that the UK economy would not only avoid a double dip recession, but was on the long, albeit slow path to recovery.
There were always risks however. The Q4 GDP report first released in January showed negative growth or a contraction, but the final version, released yesterday was unexpectedly revised lower still, suggesting the economy had a deeper hole to climb out of than anticipated.
Now sentiment towards the economy has turned negative. Analysts are now talking about Q1 GDP also being negative meaning the economy is back in recession.
Why the change of sentiment and what does it mean for Short Sterling futures?
The change of tone began last week when on Thursday 22nd March the ONS released a much weaker than expected retail sales report.
Since the UK economy still relies heavily on the service sector for much of its growth and probably will for the foreseeable future, and consumer demand/retail sales makes up the lion’s share of that, the retail sales report is a good guide to the health and strength of the economy.
When last week’s report came in below consensus at -0.8%m/m and 1.0%y/y, there was a sense of great surprise since two weeks earlier the PMI Services survey came in at 53.8, suggesting a different picture entirely. In fact we judged it was likely a one of that would be reversed by the March retail sales report when released in April.
But the OECD has today released a report showing they expect UK Q1 GDP to be negative and although their forecasting record is not beyond question, it has solidified a more pessimistic tone in the market. Further, more some private forecasts are giving a similar forecast.
So where we anticipated a reshaping of the Short Sterling curve, with the back months coming under growing selling pressure as traders expected to focus on what was meant to be a slowly building recovery, a different outcome is now being anticipated by the market.
While we do not expect Short Sterling to stage a strong rally, official short term interest rates standing at 0.50% and cannot fall much further, but the degree of tightening that traders had begun to build into the futures strip, will now be reduced.
In fact, if the OECD and other forecasts prove correct, the Bank of England may be obliged to extend their Asset purchase program further. The next few weeks will be crucial. Next week sees the release of another batch of PMI surveys and all eyes will be on the Service sector version, after that Retail sales and then mid-April Q1 GDP.
We still expect the UK economy to just avoid recession, but Short Sterling isn’t now a sell.
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