Foreign Exchange - UK Weekly Update - Monday, May 18, 2009 13:13 - 0 Comments

Shaping up for recovery – World First’s Sterling Update – 18th May 2009

Shaping up for recovery

 

The recent bull run finally paused for breath last week, as equities worldwide were down, and safe haven currencies the dollar and yen advanced. Meanwhile, the pound marched on to four month highs against the dollar on the back of better than expected retail and manufacturing sales figures. However, as the general rally in risky assets begins to stumble, investors have begun to question how sustainable the recovery is, and what pattern does the future hold?

 

Alistair Darling and the Treasury stirred sentiment in the recent budget, forecasting a contraction of 3.5% for 2009, with growth rising to 1.25% in 2010, implying that growth would rebound sharply in a ‘V shaped’ pattern.

 

Victor Zarnowitz, a leading scholar in the field of business cycles was made famous in part for the ‘Zarnowitz rule’, which states that deep recessions are almost always followed by rapid rebounds. This view is strengthened by empirical evidence which shows that since the 1930’s there hasn’t been a recession in the UK that wasn’t followed by a sharp rebound. Recent economic fortunes would also vindicate this perspective for the moment, as equities and risky currencies have rebounded strongly since March lows.

 

But we are not out of the woods yet, as while the Zarnowitz rule may be true is most cases, according to the International Monetary Fund (IMF) “recessions that are either associated with financial crises, or that are highly synchronized worldwide have historically been longer and deeper”.

 

If this plays out, the UK may be in for a growth pattern closer to an elongated ‘U shape’, as growth takes a while to recover and filter through the wider economy. This is in large part due to the stress that banks have been placed under; as the normally effective stimulatory action from central bankers, (lowering interest rates, quantitative easing) is less effective than recessions with healthy banking systems. Banks look to more selfish measures of mending their own books before passing on any benefits, in the form of credit, to the wider economy. The Bank of England realise this may be the case, and in last week’s inflation report noted that the UK was likely to face a “slow and protracted recovery”.

 

It is also conceivable that this is simply a bear market rally and we will see a ‘W’ shaped recovery, with large swings up and down, and (hopefully) with an underlying trend towards recovery.

 

The shape of this recovery is important for sterling’s prospects, as the faster the rate of improvement (or slower the rate of decline) sets a rosier outlook for the pound. The worry is that we are all wrong and the market economy takes another permanent turn downward, although this looks unlikely. As Alistair Darling commented “It means there’s no plan B should the economy not do a U or V shaped recovery”.

 

Euro zone GDP results last Friday knocked the euro down a peg, as figures revealed a larger than consensus contraction. Most worrying was German GDP slumping to the worst result in 40 years. Conversely, the yen was a big gainer last week, as figures showed that investment flows were favourable for Japan during the month of February, meaning that the flow of money into foreign securities had abated.

 

This week sees further room for sterling appreciation with plenty of data due. Tomorrow sees the release of CPI and RPI figures, Wednesday shows industrial trends as well as BoE minutes, while Thursday shows a release of retail sales figures. Data from the US will be centred around FOMC minutes on Wednesday and the Euro zone has construction and PMI readings to contend with.

 

Trade of the week

 

The Target Accumulator Redemption Note (TARN) is an attractive option for a seller of GBP and a buyer of EUR over a 5 month period.

 

The client is given a strike rate of 1.15 with 7 big figures (on GBP/EUR) to use over the 5 months. The strike rate a TARN provides is significantly better than the current spot and forward rate of 1.13 The client is obligated to buy €100,000 at expiry per month for 5 months at the strike rate of 1.15 until either the benefit of the 7 big figures has been used, or until the end of the 5 months. E.g. if spot at expiry is 1.13 for the first month they will sell at 1.15, and have used 2 cents of the total benefit of the 7 cents (leaving 5 cents of benefit to be used over the remaining 4 months). However, if spot at expiry is above the strike rate, the client is obligated to buy at the strike rate. Once the 7 cents are exhausted, the TARN ceases to exist.

 

Please note that this cannot be considered a hedge as it doesn’t carry a worst case rate. This product is suitable for clients currently un-hedged due to the low value of sterling. Like all of our option structures, this is also available in other major currency pairings. For full details of this structure please contact one of our options traders on 0207 801 9050.

 

Enjoy the week

 

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Please feel free to contact me (rick.roache@worldfirst.com) if you have any questions or thoughts regarding these updates or if you are interested in a particular event in the calendar. If you would like to discuss your foreign exchange requirements, please contact our:

Corporate Foreign Exchange Team on 020 7801 9050 or our Private Client Currency Exchange Team on 020 7801 9080.

 

To view any past or present currency blogs please click on the following link www.worldfirst.com/blog

 

Disclaimer: The above comments are only our views and should not be construed as advice. You should act using your own information and judgement. Although information has been obtained from and is based upon multiple sources the author believes to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. All opinions and estimates constitute the author’s own judgement as of the date of the briefing and are subject to change without notice.

Any rates given are “interbank” i.e. for amounts of £5million and thus are not indicative of rates offered by World First for smaller amounts. E&OE. Definitions of jargon/market terms can be found in our Glossary of Foreign Exchange Terms.

 

This financial promotion is issued in the United Kingdom by World First Markets Limited which is authorised and regulated by the Financial Services Authority (“FSA”) to provide advice on and execute trades in derivatives.  Please note that other activities that may be referred to in this material, such as the execution of spot foreign exchange trades, do not fall under the remit of the FSA.  World First Markets Limited’s FSA Firm Reference Number is 477561.

Investing in any of the hedging strategies contained in this material involves certain risks, for example that the exchange rate at expiry of the contract is less favourable than if you had entered into a forward contract.  Please ensure that you fully understand these risks before investing.  If you are in any doubt as to the nature of these risks, please speak with your financial adviser or an adviser at World First Markets Limited.

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