British Pound Posts Strong Gain on Government Creation
The GBP USD advanced after it was reported that an agreement to create a new
government had been reached. Traders celebrated the news that the Conservative
party and the Liberal Democrats had formed a coalition to create a majority in
the Parliament. The move by both parties helped put an end to the long-standing
rule of Prime Minister Gordon Brown and the Labour Party.
The formation of a new government is seen as a positive for the British
Pound at this time because it provides clarity to an almost dire situation. For
weeks the Sterling
has succumbed to selling pressure due to the possibility of a hung parliament.
This situation would have created a problem because it would have made it
virtually impossible for the new government to enact the austere fiscal
measures needed to balance the budget and reduce the countryâ€™s debt.
The clarity provided by the â€śnew coalitionâ€ť between the Conservatives and
the Liberal Democrats comes at an important time because of the events taking
place in the Euro Zone. The formation of a new government will help to provide
the psychological boost the British Pound needs to reverse the current down
Technically, the GBP USD rallied after successfully testing a minor retracement
zone at 1.4765 to 1.4695. The subsequent bottoming action and upside reversal
helped form a secondary higher bottom which attracted fresh buyers. Based on
the main range of 1.5523 to 1.4474, traders should look for a short-covering
rally to the first 50% retracement level at 1.4998. Upside momentum through
this level could drive this market into the next retracement point at 1.5122.
Despite the strength in the British Pound and the major commodity linked
currencies, the U.S. Dollar Index managed to post a modest gain on Monday. Most
of this was due to how the trade weighted index is formulated. The index would
have finished even higher had the Dollar/Yen been able to hold on to its
After a one day reprieve following the announcement of the European Unionâ€™s
$1 trillion bailout package, the Euro once again traded weaker throughout the
trading session. The current downside momentum suggests that the market has the
power to take out the recent bottom at 1.2518.
The historic announcement by the EU over the week-end failed to generate
enough investor confidence to support the Euro, but more importantly reaffirmed
that the destiny of the Euro is clearly in the hands of the hedge funds and
The fact that the Euro traded sharply lower ahead of the New York session was a strong sign that the
euphoria of the past 24-hours was over and that reality had returned to the
Forex markets. Simply stated, Mondayâ€™s trading action demonstrated that traders
accepted the fact that the EUâ€™s aid package was a short-term fix, but that over
the long-term, the economic problems in the Euro Zone would continue to exist
long after the new money was sucked into the financial system. The post-bailout
package sell-off in the Euro also served as proof that the market doesnâ€™t
believe that a country solves a debt crisis by issuing more debt.
The rejection by the market of the rescue plan served as notice to the EU
community that there is little doubt that the only way to avoid the spread of
contaminated debt in the Euro Zone is to implement further austerity measures
rather than pile debt upon debt.
Tuesdayâ€™s weakness the Euro was also a strong indication that the market was
discounting the inevitable that the debt of Greece,
Spain and Portugal are
getting very close to being declared â€śjunkâ€ť by the credit rating services.
Besides the fear of contagion over the short-run, Euro investors are dealing
with the real possibility that the bailout package will be a drain on European
economic growth. The implementation of the unprecedented bailout package means
that resources will be used to fill in â€śholesâ€ť in the economy rather than sow
the seeds for future prosperity.
Flooding the market with excess liquidity will force the European Central
Bank to keep interest rates low for a longer period of time. As other major
central banks begin to withdraw stimulus and hike interest rates, investors
will shift investments out of the Euro Zone and into these higher yielding
currencies putting additional pressure on the Euro.
Early during Tuesdayâ€™s trading session stronger gold, crude oil and equity
prices helped drive up demand for higher yielding currencies such as the
Canadian Dollar, Australian Dollar and New Zealand Dollar. Although gold
finished sharply higher, the sell-off in the stock indices into the close
turned the Aussie and Kiwi lower and helped the USD CAD trim some of its loss.
Higher equity prices also gave the USD JPY an early session boost, but this
support caved in late in the trading session when U.S. equity markets failed to
hold on to their earlier gains. Look for continued weakness in the Dollar/Yen
pair if stocks begin to retreat. Further weakness in higher risk assets will
drive nervous investors into the lower yielding Japanese Yen.
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