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20 Jul 2021
Why is the pound dropping? Elementary, my dear Watson
In the second instalment of our new “Thoughts of an FX Trader” article series, Head of FX and Interest Rates Trading Demitri Theodosiou investigates what's behind the pound's recent fall.
Thud, crash… then silence. Yes, most parents will be able to sympathise with yesterday’s episode in the Theodosiou house. I entered the room to find a cupboard knocked over and damaged, with toys strewn across the floor. Two very quiet little faces peered back at me, trying to look as innocent as possible. I was met with the usual “It wasn’t me, it was him”, and I had to become Sherlock Holmes to figure out what had happened and how. It is safe to say in my house that it is usually my youngest when things are wrecked, but you typically have to give them both a thorough questioning to see who cracks and confesses. The tears followed as they protested their innocence, and as with most cases, they ended up working themselves into such a state of upset over the mess that the whys and the hows became a secondary thing.
I’ve felt the same way staring at my screen during the last few trading days. GBPUSD is dropping towards the bottom of its recent range, having tested the highs just over a month ago. It is a similar Sherlock Holmes skill needed on the trading desk to determine why currency pairs trigger a one-way move. Is the pound weakening because of a shift in UK’s economic performance or monetary policy outlook? Is the US dollar strengthening due to higher US inflation data or a flight to the safe-haven greenback?
Can the pound find some support from bargain hunters, or will it break back below its recent range?
Well, on balance, it seems to be the latter, although, as with my kids, there is usually more than one guilty party. Covid cases are rising and unlocking plans seem less irreversible in the UK and abroad than they once did. The vaccine rollout continues at pace but is still some way from completion in developed economies, and all asset types seem to be digesting the reality that cases can still rocket and economies can still be affected – and that reality is likely here to stay. Stock markets worldwide have seen red, and even US bonds show an unwind of the reflation trade the market had been pricing in after stronger-than-expected growth and inflation data across the pond.
There is undoubtedly a risk aversion feel to things in the short term, and although it is hard to pinpoint the exact catalyst, the feeling is growing. Much like my living room, the market seems to have spilt its toys across the floor with a thud, and market participants are examining the faces of the usual suspects to determine why. Can the pound find some support from bargain hunters, or will it break back below its recent range? Regardless, if the dollar continues to strengthen at pace, the market will become more concerned with the size of the move and the whys and the hows will become a secondary thing.
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