Pound Cools off after Sharp Plunge
The floor collapsed from under the pound over the past week. There wasn't a specific catalyst for this move; but the pressure that has built up behind a slow recovery, a ballooning budget deficit and impending general election offered more than enough fuel to stoke the selling fire. Did this move completely purge the currency of its risk? Unlikely. Such a correction was an understandable adjustment to put the currency back into line with the uncertainties that the economy and government face. Further progress from the pound itself (meaning outside the influence of underlying risk appetite trends or cross market flows) will likely come through speculation and the outcome of the upcoming election. Prime Minister Gordon Brown doesn't have to call the election until the first week of January; but many believe he will do so earlier. If during the polling popular opinion is as mixed as it was in the March 1st YouGov report, then the potential for a hung parliament could thwart the necessary steps to work down the government's deficit while simultaneously balancing growth. This is a collective inhale fundamentally; and it isn't clear when sterling traders will be able to breathe again.
Given the uncertainty that faces the UK economy and its currency; it is difficult to establish positions that can be expected to have a reasonable level of stability. Over the past few weeks, GBPUSD pitched into its sharpest decline in 16 months. If there is no particular news event or a significant shift in underlying sentiment, the market could be left to slowly retrace. However, the slow bounce would carry the major threat that another shock can send the currency reeling. Therefore, there is a balance between the scenario will market's are calm and active. For a calm position, I like a very reduced setup for EURGBP. A short entry order at 0.9130 will be held open to the end of the week with a stop at 0.9205 and first target at 0.8980. For breakout potential, I think the recent congestion on GBPCHF can open up to another leg of declines below 1.60. I will look for confirmation of a close below this level with a stop above Tuesday's high and position size sharply reduced to account for this notional risk.
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