BY Mario Sant Singh
Director of Training & Education
FXPRIMUS
Late last week, top ratings agency Moody’s dropped a bombshell on the UK by stripping it off its prized AAA rating - a first in history.
Moody’s cited weakness in the nation’s growth outlook and challenges to the government’s fiscal consolidation program when lowering the AAA rating one notch to Aa1. In an official statement, it said that the main driver of their decision "to downgrade the UK's government bond rating to AA1 is the increasing clarity that, despite considerable structural economic strengths, the UK's economic growth will remain sluggish over the next few years due to the anticipated slow growth of the global economy and the drag on the UK economy.”
Immediately after the announcement, the GBP/USD pair fell about 75 pips. The fall would have been bigger if not for the fact that the US market was just about to close. When markets opened early Monday morning, the GBP/USD gapped down about 50 pips and broke below 1.51, its lowest level since July 2010.
The opposition Labour Party in UK has been breathing down the neck of George Osborne, Chancellor of the Exchequer, calling on him to scale back his fiscal squeeze, and the latest blow by Moody’s will add to that political pressure.
Although the rating cut seems harsh, it is warranted. After all, recent economic reports do show that the UK’s recovery is losing momentum. GDP growth shrank 0.3 per cent in the fourth quarter of 2012, leaving the country on the brink of an unprecedented triple-dip recession.
Retail sales also fell in January. In fact, consumption failed to increase for the past 4 months and conditions are so worrisome that Bank of England Governor King voted with the minority this month in favour of more Quantitative Easing. If the UK prints more money to finance its debt, the GBP/USD could fall even further.
As it is, the Sterling has depreciated about 5.6 per cent this year; the second-worst performer after the yen among 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes. According to a statement by the European Commission, Britain’s debt as a per centage of GDP will steadily climb from 90 per cent last year to 95.4 per cent this year and reach 98 per cent in 2014.
The good news for UK at this stage is that their bonds are considered safe investments. Although they don’t enjoy the same fame as US Treasuries, the chance of the UK defaulting on its bonds is very slim.
With budget day scheduled for 20th March, the other two ratings agencies, Fitch and Standard & Poor’s, could move to downgrade the UK if they are not convinced with Chancellor Osborne’s plans. In the short term, there is still further downside on the GBP/USD as traders and investors switch focus from their short yen and short euro trades to jump into the short sterling trade.
Top News This Week
UK: Manufacturing PMI. Friday, 1st March, 5.30pm.
I expect figures to come in at 50.9, (previous figure was 50.8).
Trade Call
Short GBP/US$ at 1.5230
On the hourly chart, GBP/US$ is moving in a strong downtrend. The outcome of the downgrade by Moody’s will be negative for the sterling and I expect further downside for GBP/US$ this coming week. The pair gapped lower on Monday morning and reached a 2 and a half year low of 1.5071.
A Fibonacci retracement is drawn and we see that prices paused near the 38.2% level. However, with the new low formed, we will wait for prices to retrace to the 23.6% level before going short.
An entry is taken at 1.5230, which is several pips above the 23.6% per cent level. A stop loss of 95 pips is placed, which is located just above the last high. We will have two targets on this trade, exiting the first position at 1.5135 and the second position at 1.5040, just before the round number of 1.50.
Entry Price = 1.5230
Stop Loss = 1.5325
1st Profit = 1.5135
2nd Profit = 1.5040
