Forex Investment and Currency Trading

EURGBP has fallen from 0.9805 to 0.8696 in just over a month, so

• Was the 0.9805 high on EURGBP the peak of a long term bull market that started in May 2000 instead of a relatively minor high?
• Can we see EURGBP and EURUSD trade in opposite directions thereby potentially implying an aggressive rally in GBPUSD?

The analysis here leads us to think that the answer to the questions above is YES.

The last time EURGBP fell while EURUSD and GBPUSD rallied was from May 2003 when EURGBP peaked at 0.7255. What was going on in 2003?…

The last cycle low in interest rates saw the following

• U.S. 2 year yields based in June 2003 at 1.03% and were at 2.94% by June 2004
• U.K. 2 year yields based in March 2003 at 3.07% and at 5.12% in July 2004
• German 2 year yields set a low in June 2003 at 1.84% BUT did not trough until March 2004 at 1.83% and effectively stayed in a 1.84% – 2.87% range for two years
• Additionally US 10 Y yields base in June 2003 and stocks had already based in late 2002

What are we seeing in the fixed income markets today?

U.S. 2 year yields and 10 year yields

Cyclical lows? Beyond Fixed Income, we are seeing good indications that many trends seen going in to the end of 2008 are likely to have reversed now as we foresee a more positive risk environment for the weeks ahead. This applies to yields, stocks, commodities in the ST, the JPY and indeed GBP.

German – UK 2 year yield and UK – U.S. 2 year yields spreads

• German – UK 2 year yield spreads: Turned from channel top…bearish indication for EURGBP.
• UK – U.S. 2 year yield spreads: Marginally overshot the 76.4% Fibonacci retracement of the rally from the lows in 2006…bullish indication for GBPUSD.

German and UK 2 year yields – ECB and Bank of England policy rates respectively

Have the ECB been aggressive enough? No. This is likely to put some pressure on German 2 year yields which are only 8 bps off the low on Jan 23rd which was at 1.32%. While it is possible that German yields can rally, they are not likely to rise as much as U.S. and UK yields.

You may be asking the question…

“If these currency pairs are starting to move according to yield spreads (as GBP has traditionally done), wouldn’t one expect a fall in EURUSD as the German – U.S. 2 year yield spread moves lower if we are to be consistent with a rise in the UK – U.S. 2 year yield spread and a rally in GBPUSD??”

Good question….the answer is “not necessarily”…

Look at what happened in 2003 around the time when U.S. 2 year yields based…

2003 Market Behaviour

The rise in U.S. yields appears to be a reflection of risk trades. And this is why it is consistent with a weaker USD. The USD is a de facto funding currency and in a less risk averse environment USD weakness is expected (similarly the JPY should weaken). Additionally the Fed is the leading central bank involved in quantitative easing / increasing money supply….the U.S currency is likely to weaken in this process as it becomes dilute (effectively devalued).

Overall EURUSD Roadmap

The above overlay remains one of our favourites. It compares the USD bear market of 1985-1992 (EURUSD as its components) with the bear market, which began in earnest in 2002 (2002-2009???). Could we see another major rally in EURUSD?

EURGBP LT chart – It has peaked

• Clear 5 wave pattern from the lows in 2000.
• A Fibonacci projection measured from the lows and the top of wave 3 has picked the recent high almost to the pip (261.8%).
• Triple negative momentum divergence on the monthly chart warns that the uptrend is tired and is at risk of reversing.
• Interestingly the lowest close on 30th Dec 2008 in GBPDEM was 2.00

GBPDEM

Non Technical thoughts

• Europeans are turning up in England and the Irish going to Northern Ireland for their shopping during a recession (a reflection of extreme valuation for the GBP?)
• How many headlines did we see about EURGBP going to Parity at the end of 2008? Probably a few too many (a reflection of extreme sentiment?)

EURGBP Weekly Chart – Significantly Bearish

Weekly evening star pattern and the high and a bearish weekly reversal posted last week. A test of the 55 week moving average at 0.8105 is expected over the coming weeks. Beyond that we expect a test of the 200 week moving average at 0.7188.

GBPUSD – Has it based?

Failed to close through the pivotal 2001 low at 1.3682 and turned marginally above the Fibonacci target from the first wave down. The pair is now testing the 55 dma and at risk of rallying to resistance levels at 1.5374 and 1.5724. The LONG TERM risk of a rally back to the 200 dma at 1.7415 cannot be written off.

Overall

• While there is much focus on the UK real estate and labour market, they are NOT the currency market
• The real estate market, spending and employment in the UK are all likely to continue to fall, that we do not dispute…but it does not necessarily mean the currency falls too.
• The following must be recognized when considering the outlook for GBP
• Sentiment of late appears to have been too aggressively bearish for the GBP
• The Bank of England implemented aggressive policies to deal with the current economic climate, something that can not be confidently said for the ECB
• GBP has traditionally been well aligned with yields. While the Bank of England rate is at its lowest level in history, yields along the curve are significantly higher. (UK 10 year yields stand at 3.68% and 30 year yields at 4.27% for instance). UK 2 year yields are particularly important.

There are similarities between now and when the interest rate cycles turned in 2003. The USD weakened, but more against the GBP than the EUR and as a result the market went through a period where EURGBP and EURUSD traded in opposite directions.

One believes that the same could happen again and that the long term bull market in EURGBP is over. One believes the high set at 0.9805 on EURGBP (or the low at 2.00 on GBPDEM) was indeed THE high and that the weeks and months ahead will likely see an aggressive bull market for the GBP.