The week started very well for sterling as the carryover from last week’s optimistic US GDP data, and the previous Friday’s large levels of institutional fixing set a platform that launched sterling into its highest levels of the year.  Global equities rallied, with the S&P hitting 1000 for the first time since September, and FTSE at its highest levels of 2009.  ‘Risk on’ was the cry, and sterling benefited early week, breaking into the 1.70’s for a period.  Moreover, UK Manufacturing PMI data printed at 50.8 for July, finally indicating an expansion within the sector. 

Reporting season is upon us, and HSBC and Barclays began the week with exceptional figures that stoked the fires of the bull market both for UK banking equities and currency markets.  Lloyd’s figures could not have been more contrasting, and although Lloyd’s shares rose it was a stark reminder as to the extent of the malaise in UK banking sector.  For completeness, I should mention Northern Rock results were as diabolical as expected.

The release of pleasing UK services figures on Thursday (53.4 vs. 51.8) jumped sterling up almost 1% against both USD and GBP.  But fortunes can turn in the blink of an eye.  The major event risk of the week was the Bank of England meeting, with concerns they may expand the Quantitative Easing policy to the full £150Bn they were initially set aside.  However, Mervyn King et al instead announced it would expand fiscal policy by a further £25Bn, taking the total to £175Bn, sending sterling on an immediate nosedive.  The ECB rate decision followed later, announcing they would hold rates again and not engage in any unconventional policy, highlighting the stark contrast between two Bank’s approaches.

Fridays Non Farm payrolls figures again signalled a sea change in the global economy.  Non Farms was expected at -340K, supported by poor ADP rising unemployment rate, yet it reported at -247K.  The USD strengthened on the back of this positive figure, the first time in some while that strong US domestic data supported the greenback.   Sterling ended the week lower at around 1.67 against the dollar, but has continued its almighty tussle with the single currency ending the week grappling in and around 1.17’s.

Events of the week to look ahead for is a flash reading for European GDP on Thursday, and FOMC minutes from the last meeting due on Wednesday. The Bank of England’s inflation report will be delivered at 10.30BST on Wednesday.  This is the major news expected in the week ahead and it will certainly sculpt sterling’s fortunes.  We anticipate Governor King to reiterate the comments made by Sushil Wadhwani, a former MPC member, who recently raised concerns that the UK may follow a similar path as Japan in the 1990’s.  Japan overcame the initial crisis but experienced a protracted 20 year period of stagnation.  King is expected to state that QE was extended in order to prevent the UK falling victim to the same debt deflation trap as Japan.

We anticipate the Bank to concede that the worst of the recession is over but they have been eternally cautious throughout the crisis, and so it is no wonder that potential recovery is being treated as equally serious and concerning as the abrupt decline itself.  Whilst all expect economic indicators to recover in the UK the spectre of Government debt will loom large in the weeks and months to come.  If the budget cannot be reined back in it could become increasing relevant to individuals living in the UK.

This week has taught us just how delicate a balance the Bank of England must strike to get us across the tightrope unscathed. Whilst we are still sterling bullish we reiterate the long stated fact that the frequency of unexpected events remains so high that it is foolish to take anything for granted.

Trade idea of the week

This week’s trade idea is a strategy rather than an option, and is called the ‘ratio forward’. It is a synthetic combination of two existing strategies (the participating forward and convertible forward) which are weighted 50% each. For a seller of sterling and a buyer of euro’s, this client took advantage of a strong pound, hedging themselves until the end of the year.

When combined, these strategies mean that the client was able to guarantee a worst case rate (WCR) of 1.61. If spot at expiry had never traded at or above 1.80, the client was able to benefit in 75% of the favourable movement. If 1.80 is ever touched, then half of the exposure is reverted to a forward at 1.61, and you continue to benefit in 25% of any further favourable movement.

This strategy requires no premium, and is relevant for other currency pairs. As there is a potential strengthening for sterling in the future, it provides a balanced upside for this potential, while guaranteeing a tight WCR.

For full details of this structure please contact one of our options traders on 0207 801 9050

Have a great week