• Home ::
• Fundamental ::
• Market View ::
• Weekly Market Update

• Send
• Print
• Add To
• Rss

Weekly Market Update

ed396550-287a-4963-9405-9d4ba3afdbea

7

0

Picking Through The Rubble Of GDP

Tue, Oct 27 2009, 07:27 GMT
by Alex Sullivan

World First UK Ltd

Last week was shaping up to be alright for the pound. The beleaguered sterling was making inroads against both the euro and dollar whilst extending against the G10 basket as well. It wasn’t spectacular; it wasn’t extravagant; in fact it was really quite British in its lack of exaggeration. But obviously channelling the strength of our cricket team the pound, after a promising start, collapsed on Friday erasing all the gains it had strived so hard to acquire and the disappointment indeed involved shame and loss.

The poor GDP figures can likely be attributed to consumers deciding to pay down debt as opposed to spending on the High St and businesses as a result have been ‘destocking’; running down bloated reserves of goods and not ordering more until certain levels have been reached. The main fallers in the GDP figures were those involved in the wholesale and distribution sectors alongside typical recessionary laggards such as hotels and restaurants.

One of the main risks to recovery is that this continues and businesses, banks, consumers, and HM’s government further concentrate on lightening the debt load, with the ensuing demand decline so heavy that unemployment recuperation does not get off the ground for years and years. This could of course be eased by further spending but from where?

Members of the MPC, Adam Posen excepted, have been relatively tight lipped over the possible expansion of the Asset Purchase Program or Quantitative Easing we are now more likely to see in November. In fact the major catalyst for sterling’s rise last week was the lack of talk about QE in the minutes of October’s MPC meeting. Mervyn King has previously caused GBP to swoon violently but found it necessary to keep his mouth shut over further injections in October.

If we assume that August’s £50bn increase was a form of insurance in the manner of “better to have too much and not use it than not and go hungry” then we must assume that a similar figure of QE will be injected in November.
Inflation has probably bottomed out in the UK and is likely to remain subdued even though oil is struggling higher and the pound is so weak.

We have therefore reappraised our expectations for an interest rate increase by 0.5% in 2010 from February to July.
We hope by that time that the UK’s inflation picture will have picked up and that growth is a reality and not just a dream like it is at the moment.

We were all disappointed by Friday’s GDP announcement and probably a little ashamed by the realisation that the economy is not as strong as we once thought. Another dose of QE medicine from the MPC will be needed before the economy is back on its feet. While it’s ok to harp on about the underlying problems and the reasons why we’re here surely our time and money is better spent on getting out of the hole than arguing about what shape the hole is, whose hole is it and whether the hole could have been avoided.

Trade of the Week

This week’s trade idea is a strategy rather than an option, and is called the ‘ratio forward’. It is a synthetic combination of two existing strategies (the participating forward and convertible forward) which are weighted 50% each. For a seller of sterling and a buyer of euro’s, this client took advantage of the combination of safety and potential upside benefits, hedging themselves for 6 months

When combined, these strategies mean that the client was able to guarantee a worst case rate (WCR) of 1.07. If spot at expiry had never traded at or above 1.18, the client was able to benefit in 75% of the favourable movement. If 1.18 is ever touched, then half of the exposure is reverted to a forward at 1.07, and you continue to benefit in 25% of any further favourable movement.

This strategy requires no premium, and is relevant for other currency pairs. As there is a potential strengthening for sterling in the future, it provides a balanced upside for this potential, while guaranteeing a tight WCR.

For full details of this structure please contact one of our options traders on 0207 801 9050

Published on  Tue, Oct 27 2009, 07:32 GMT