I am going to start posting personal trade ideas, and the reasonings behind them, here at ShadowCap. There is a tab up at the top of the site called “Trades” where you can see an archive of all of the trades, as well as their performance to date or to close (I will also be announcing when I close the trades I post).
In this pervasively liquidity-driven carry trade-funded market environment, even the pound has risen against the dollar since March 2009 lows, up from about 1.35 to about 1.64. But the massive sovereign credit risk problems facing the UK, the insolvency of its financial system, its reckless central bankers, and the reversal of the QE-financed dollar carry trade all make selling the GBP/USD cross an attractive trade.
In May of last year, Standard & Poors placed the UK’s AAA rating on negative outlook, warning of a potential downgrade. Moody’s followed suit in December, setting the UK aside as especially at risk of a AAA rating downgrade. PIMCO’s head of global portfolio management, Scott Mather, took these warnings as expressions of legitimate risk, risk of inevitable crisis:
Based on what we know today about the debt trajectory and about the inability to adjust that, I think it’s greater than a 50% likelihood for sure. Call it more like 80%.”
Meanwhile, the first central bank to explicitly issue QE in response to the financial crisis, the Bank of England, is under fire for a record sequential jump in inflation rate, spiking to 2.9% in December from only 1.9% in November. This should add selling pressure to the GBP, which has already been facing headwinds because of the UK’s credit problems. The GBP has underperformed other risk currencies, like AUD EUR CAD, sharply, especially August 2009.
With the dollar reversing its post-March 2009 downtrend, and QE liquidity drying up, the dollar carry trade is unwinding and preparing for a large reversal. Already, the EUR/USD has retraced more than 35% of its rally since March and is beginning a sharp new downtrend. Deleveraging of dollar-denominated debt on the real economy level is affecting cash flows that will eventually lead to a rush to dollars, as well as a rush to liquidity/safe haven, both of which will be bullish for the USD in that timeframe.
This makes going long USD a great trade at these levels, and the GBP is an attractive pair to sell the USD against, given that it’s a great short against most major currencies.
Technically, the cross is hovering in a range it’s been in since last summer. With the news of the inflation rate record and a reversing USD, right here around 1.64 is an attractive trigger point. Not to mention it topped out last summer at around 1.71, a very significant multiyear support/resistance level. A breakdown below support at 1.58 will trigger a larger bearish position.