GBPUSD Weekly Fundamental Forecast - 09.06.10

A forceful recovery in risk-taking promises gains for the British Pound as sentiment remains the dominant catalyst of price action, with GBPUSD showing a correlation reading of 0.64 with the MSCI World Stock Index on 20-day percent change studies. However, seasonal factors may complicate the risk landscape while monetary policy will vie for attention however as the Bank of England delivers an interest rate decision.

Risk appetite staged an impressive comeback as US economic data surprised sharply to the upside throughout last week, starting with a outperformance on the consumer confidence reading, followed by an unexpected pickup in manufacturing growth, and closing out with a much stronger than expected jobs report. Equity markets responded accordingly as traders continued to look to the health of the world’s largest consumer market as the bellwether for the global recovery at large, with the MSCI World Stock Index snapping three consecutive weeks of losses to add 3.7 percent, the most in two months. The docket of US event risk pales by comparison in the week ahead, seemingly suggesting that little stands in the way established pro-risk momentum and promising continued gains for stocks and related currencies.

Despite wading through a docket of otherwise unremarkable and disappointing event risk, risk appetite would find a foot hold this past week and subsequently send the US dollar lower. Looking at the trade-weighted dollar index, we see the single currency fell for four consecutive sessions and closed this past week on the verge of a far more progressive bearish reversal. Is this an inevitable shift in the tides for the benchmark currency after a failed month-long attempt to catalyst a bull run? To determine whether this is the case, we will likely have to look outside the narrow confines of an otherwise light economic docket and turn our focus to the normal culprit for larger trend developments: investor confidence.

Heading into the new week, we should maintain realistic expectations for price action through the first 24 to 48 hours of active trading. The US markets will be closed Monday for the Labor Day holiday. And, though the absence of US institutional money doesn’t force the FX market to grind to a halt; this particular center of finance is heavily influential when it comes to defining global levels of risk appetite or aversion. It isn’t a coincidence that a rally, reversal or stall in the US session is carried over into the preceding Asian and European hours of the following continuous trading day. That being said, there are few foreseeable fundamental swells that can reasonably be expected to spark a meaningful shift in positioning (into or away from risky assets). In fact, the coming week’s global docket is exceptionally light when it comes to fodder that can stir confidence or fear in the more prone corners of the globe. Naturally, we would expect this to translate into a quiet market. Quite the contrary. It is frequently those periods that are lacking for definable economic indicators that see trends develop. A possible reason for this phenomenon is that the threat of volatility from a specific event can curb traders’ interest in building or unwinding trades. When the coast is clear, market participants are more comfortable in taking large positions without the fear of temporary volatility. What’s more, as speculative trends build; the move cannot be brushed off as a asinine and temporary reaction to a specific piece of data.

When establishing the natural bias of investor sentiment over the coming week, we already see the technical lean. The fact that this bearish bias (actually a rise in risk appetite) has developed despite the questionable performance of manufacturing activity (one of the last bastions of hope when it comes to growth) and employment (at the pace of job growth we are running at, it would take five or six years to reach the old level of normal), confidence is still buoyant and the safe haven dollar under pressure. It seems in the absence of panic-inducing events, the natural bias is risk appetite. That being said, important milestones ahead including consumer credit, the trade balance and the Fed’s Beige Book will be reviewed with an optimist’s bias.

That said, the week ahead marks an important seasonal turning point – the US Labor Day holiday – which typically serves as the line in the sand between the “summer doldrums” period when most traders are on vacation (usually marked off starting with the US Memorial Day holiday at the end of May) and the time when they return to the markets. Equity markets crept higher to add 4.8 percent between the Memorial and Labor Day holidays this year, thoroughly outdoing the historical average of less than 1 percent over the same period, but trading volumes plunged by a hefty 31.4 percent. This seems to undermine the conviction behind recent gains, hinting at the possibility that last week’s outperformance may have been the last gasp of a move soon to be reversed as investors put the summer behind them.

An interest rate decision from the Bank of England highlights the domestic economic calendar, but the outcome may not prove market-moving with policymakers unlikely to offer anything that has not been priced in for some time already. Expectations call for both key elements of monetary policy – benchmark borrowing costs and the QE asset purchase target – to remain unchanged at 0.5 percent and £200 billion, respectively. The central bank has argued for some time that the upswing in prices since the beginning of 2010 owes to temporary factors, with the annualizedinflation set to fall back below 2 percent by 2012.Given such a prolonged time frame, Mervyn King and company are surely going nowhere fast despite a promise to shift policy “in either direction” as needed, a likely nod toward the threat of headwinds from the government’s austerity program. Indeed, a Credit Suisse gauge of priced in rate hike expectations hints traders are betting on no changes in benchmark borrowing costs at least until the second half of 2011, a view in place since early August.