“Traditional” economic drivers being ignored

An economy in which in interest rates are being increased and a currency that is seeing a widening of interest rate differentials would generally expect to be growing at above trend.

We now seem to be in a “reverse Trump trade” where the President is having an adverse effect on the currency. In his mind, he is probably congratulating himself on making U.S. exports more competitive but, as has been seen in the U.K., a currency in freefall has its own implications for inflation.

Trump’s sacking of his Communications Director Anthony Scaramucci after only a week in the job is the latest in a long time of bizarre actions that are starting to severely undermine his Presidency. The new White House Chief of Staff Gen. John Kelly is facing a tough job to repair credibility before he can even start to push the Presidency forward and support the administration’s reform and stimulus programmes.

The dollar has fallen to a two year low as the Euro which makes up 53% of the dollar index soars, closing at 1.1831 seemingly unstoppable on its way to 1.2000. The pound which is facing its own headwinds also made new multi-month highs reaching 1.3225 despite losing ground against the common currency.

MPC meeting not completely “clear cut”

Six weeks ago, at the previous BoE MPC meeting, three members voted for a rate ostensibly to ward off inflation that looks like it was likely to break 3%. In the event, June’s data showed a fall from 2.9% to 2.6%, still above the Government’s target of 2% but a welcome reversal.

Governor Mark Carney has been at pains to say that the market shouldn’t regard one month’s data in isolation.

This week’s MPC meeting while not attracting as much attention as had been previously expected will be accompanied by the release of the latest quarterly inflation report.

The MPC should be forward looking in its interest rate judgement as it need to be able to predict inflation two years hence. The rise in the value of Sterling against the dollar has halved the fall following the Brexit referendum and that will have had a dampening effect on inflation.

The Bank’s own Quarterly Inflation Report will bring some clarity to what it is thinking and may influence hawks to push for a rate increase. Another of Carney’s “nuggets of wisdom” is that the overall economic situation needs to be considered and how inflation will be driven by several diverse factors. The economy is slowing both by the U.K.’s own and the IMF’s measures so that will need to be taken into consideration.

When will the correction come?

Any traders most used phrase is “the trend is your friend”. It is very much “trading 101” to use trend analysis as the basis of any trading model. However, spotting the end of the trend is the subject of many chapters of “experts” guidance.

Right now, the dollar could not be in more of a downtrend but history tells us that all trends come to an end. It may almost require a “black swan” event to turn the dollar around as it seems to be breaking major supports on an almost daily basis.

The nature of a black swan event is its unpredictability so it is impossible to even speculate.

The market is like an elastic band that is being stretched to breaking point. As any technical analyst knows, the further the market moves in one direction, the deeper the correction can be while remaining within the overall trend.

Why do we wait for the correction? A novice will feel that he has missed the up move and will try to use the correction to make some money. A more experienced trader will use the correction to enter or add to a trend following position.

Does there have to be some “event” to bring about the correction? No, not really. At some point the buying interest will run out as those willing to sell run out of buyers and prices get marked down. As that happens the weaker longs will be “washed out” and a correction begins. The psychology of the market then kicks in and trading models and methods are tested.

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Alan is a highly experienced banker with an in depth knowledge of Corporate Banking, Treasury and Trade Finance. He has had a varied career in Global markets, Risk management, FX Trading and Sales & Interest Rate Management. He has managed sales teams mentoring his team in both markets and marketing.He has been published in a number of journals and has appeared daily on radio to discuss market movements and events. His first novel was recently published.