It`s always an interesting exercise to analyse the psychology behind trading behaviour, and this morning`s price action in sterling is a case in point. The UK unemployment numbers come out slightly better than expected, and the MPC minutes say what we have got used to the MPC minutes saying, nothing new. This set of unemployment figures – as most people will concede – are not going to change the MPC outlook, nor alter in any way, the timetable for a rise in interest rates; yet the market buys sterling. The reasons for this are two-fold.
Firstly the numbers underline the continued economic health of all things UK, and even if the figures were on target or slightly worse, they wouldn`t have been enough on their own to burst the bubble; buyers would have come in on any dip. Underlying sentiment, either pro or con, is a powerful and at times illogical force in our market – vis the Euro for much of the last portion of 2013! Secondly, the markets default setting is always to look at expectations of any indicator, compare the actual, and buy if better, sell if worse. It is only in the aftermath when the figures are analysed for their implication rather than for their individual worth that a perspective is introduced. The interpretation of all this is that even though a trader may understand and acknowledge the lack of actual impact the numbers will have longer term, they believe that the rest of the market will act in a knee jerk manner. Therefore to apply too much individual logic to the publication of economic statistics on release is often dangerous (NFP!!) Much more important, is to understand the underlying sentiment and positioning, wait for the knee jerk reaction to take place, and then trade in a more informed way.
With sterling, what`s not to like! The good news just keeps getting better, and sentiment is strongly positive. Very much the market darling for now, and in a world of competitive devaluation, very much a `currency of least resistance`. Enjoy the ride, but beware the element of expectation. There is a momentum building up here, based on the argument that potential GDP growth will force the MPC to raise rates sooner than expected; but even if that turns out to be true, we are talking about 25bp`s, and even on the most extreme forecasts, not until the late 3rd quarter at the earliest! It is essential in order to keep this positive vibe intact, that the shape of growth trends away from consumer led demand, and it is this, rather than the pure numbers that will define the performance of sterling later this year.
Sustainability, is a word that we will increasingly see when applied to UK growth, and without increased business investment moving up sharply, doubts will (rightly) be cast about the sustainability of growth going forward.
