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By Shavasb Bohdjalian
When the Fed launched its first quantitative easing programme two years ago, the dollar fell sharply as market participants sold on the notion that since the Central Bank was printing money to buy bonds in order to push interest rates lower, it was weakening the currency. The same pattern of trading occurred when the Fed announced QE2 a year ago and the dollar came under selling pressure.
Most traders believed the same pattern would also be true in the case of sterling, when last Thursday, the Bank of England unexpectedly announced the launch of an additional GBP 75 bln to its GBP 200 bln asset purchase programme, highlighting the precarious state of Britain's economy as global growth slows, government spending cuts and tax hikes bite and consumers face high inflation and slow wage rises.
Asset purchasing is seen as negative for the pound because the market is flooded with the currency, stifling demand and for that reason many traders forced the currency to a fresh 14-month low of 1.5270 against the dollar. In theory the pound should have continued lower, but alas, the currency turned sharply higher and shrugged off a Moody's rating downgrade of 12 UK financial institutions the following day.
Reporters attempted in vain to explain the rebound, but I doubt if traders were impressed. Some analysts said the reaction in sterling was limited because the downgrades had not been as severe as some market players expected.
Others said an excessive build-up of short positions in the wake of the QE announcement had contributed to sterling's bounce, but medium-term worries over the state of the economy kept investors wary of actively buying the currency.
A European investment bank and a UK clearer were cited as the main buyers on the day forcing the late shorts to cover positions.
With the European Central Bank keeping rates on hold on Thursday, the UK is seen leading other developed countries in the latest round of injecting funds into the market while keeping rates historically low.
Some analysts said by introducing QE in October rather than November, as many in the market had anticipated, the BoE could be seen as taking more decisive steps to tackle slowing growth, but it seems the market chose to ignore additional bearish comments that the UK’s asset purchases would be extended to total GBP 500 bln from GBP 275 bln now if the economy did not respond.
There is no doubt that the overall trend for sterling is negative since spot prices are trading below the long term moving averages, the UK economy is heading back to recession, unemployment will rise as a result of massive layoffs and the bold action by the BoE shows that the authorities are running out of options, but the price action since last Friday clearly shows that investors cannot trade based on fundamental considerations alone.
And when the ECB extends its own QE programme of purchasing government bonds and when the Fed commences its QE3 asset purchase programme probably in November, perhaps it may be good to remember the price action on sterling and act accordingly. Just because a central bank announces a QE package may not necessarily mean a currency weakening the next day, week or even month. Sometimes it works, sometimes it does not.
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(Shavasb Bohdjalian is an approved Investment Advisor and CEO of Eurivex Ltd., a Cyprus Investment Firm, authorized and regulated by CySEC, license #114/10. Eurivex is also a provider of forex white label solutions and forex brokerage packages. The views expressed above are personal and do not bind the company and are subject to change without notice. Investing in markets and trading on leverage is highly risky and it may not be suitable to all investors since it carries a high degree of risk and you can lose more than your initial investment)
