DOLLAR vs. STERLING: QE OR NOT QE, THAT IS THE QUESTION

Friday's US GDP Results May Provide the Answer



Reserved British QE vs. Aggressive American QE

Last month, the BoE surprised many forex traders by announcing that it planned to let the current stimulus program (aka Quantitative Easing or QE) expire in August, despite concerns that the flame of recovery was too weak stop fanning with low interest and easy credit.

In contrast, last week US Federal Reserve Chairman Bernanke took the opposite approach, and resisted pressure to even give even a deadline for ceasing America's stimulus program until recovery was more firmly entrenched. He emphasized his fear that because consumer spending comprises about 70% of US GDP, America could not sustain a jobless recovery.

The short term effects on the two currencies after these announcements were predictable. The GBP rose with the reduced threat of lower interest rates in the short term and higher inflation in the long term. The dollar has continued to struggle following Bernanke's comments.

Maintaining their reserved British approach to QE, the Exchequer announced that they would let their temporary reduction (from 17% to 15%) of value added tax, (part of their QE program), expire at year's end. For perspective, this VAT is well above combined US state and local sales taxes.

Are you a struggling UK business, or employed by one? A family struggling to make ends meet? Stiff upper lip, old chap. Ah well, it's said there's similar suffering for new boys in English boarding schools.

Economic data for both countries is still a very mixed bag, with plenty of bad news, and good news that is often the "less decline than expected" type, which was the vast majority of the "good news" from US earnings thus far. Decreasing rate of decline does not necessarily imply a coming recovery.


So how does the UK's decision look thus far? While it's admittedly too early to tell, the recent news is not encouraging. Last week, they reported the largest annual drop in GDP ever recorded since they began tracking it in 1955, -0.8% in Q2 and 5.6% annually.

On Tuesday July 28th, Britain's CBI Realized Sales data, a major leading indicator of consumer spending came in at -15 vs. a forecasted -12 and a previous -17.

This Friday, the US will report its own quarterly GDP figures. Forecasts are for a contraction at an annual rate of 1.5%, less than an annual pace of decline in the first quarter of 5.5%, with some analysts predicting it could be the last negative quarter.

If Friday's American GDP results meet or beat expectations, the UK may find itself reconsidering its more reserved QE approach.


Implications for Global Markets


Good For Risk Assets

This implication will not be lost on traders. If the world's largest economy looks like it's recovering, that is very good for global recovery. That means stocks, commodities, commodity based currencies (like the CAD) and high yield currencies like the AUD and NZD would tend to rise.


Good for the USD?!

Until recently, that would mean the USD should drop, because it has moved inversely with stocks and risk appetite. The USD has been strictly a safe-haven currency. However, while stocks rallied hard last week, the dollar did not drop as much as stocks rose. Some analysts questioned whether the USD was starting to trade more based on the improving fundamentals of its underlying economy.

If so, better US growth figures might spark a rally in the USD. Not only could the sterling get pounded, so could other currencies. Many currencies are at nearly two month highs against the USD, which has been heavily shorted. That makes these pairs more vulnerable against the dollar in the short term, especially if:

There is bad news from the underlying economies of the EUR, AUD, or other currency.
If this week's US treasury bond auction suggests oversupply of US debt, and thus rising US interest rates, which would support the USD in the short term.

We'll know more on Friday.

Disclaimer & Disclosure: The above opinion is not necessarily that of AVA FX. The author may have positions in the above instruments.