| Risk aversion is driving the currency exchange markets |
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| Written by Jon Beddell |
| Friday, 12 February 2010 09:45 |
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"Sterling has actually been punished more severely than the Euro over the Greek debacle." You could be forgiven for thinking that recent movements in sterling exchange rates have been largely down to two factors. The Bank of England's decision to halt quantitative easing, and the developing story of Greece's national debt and imminent financial meltdown. In fact, the QE deal was already largely expected, and although it was probably the best possible outcome (halting the printing press for now but leaving the door ajar in case things deteriorate) the news provided only modest relief for the pound, which has actually declined against almost every other currency over the last week. This latest bout of sterling weakness may seem perverse considering these two news items, but when viewed in the wider context of investor risk aversion a kind of logic does prevail. Firstly, it's not only the Greece issue that is driving investors' attitudes to risk. The winding down of QE and a sharp correction in global stock markets have sparked a move out of high risk, high yielding assets and into the perceived safety of the US dollar and Japanese Yen. These are the currencies that investors have borrowed in (at low interest rates) to reinvest in other currencies offering better returns. The dollar's strength is partly driven by an unwinding of these so called carry trades. Typically the high yielders also suffer as sellers drive them lower. This has certainly been evident for the Aussie' dollar, a favourite for carry trades as it offers a 3.75% yield compared to just 0.25% for the greenback. The problem is, although these currencies have been on the back foot against the dollar, sterling has been even less favoured. It's not a question of which currencies are most popular, but rather one of which currencies are least unpopular. Sterling has actually been punished more severely than the Euro over the Greek debacle, which on first glance is difficult to fathom. However, when you consider that the Greek economy constitutes a small part of overall euro zone GDP, things make more sense. Just a few weeks ago the rumor mill was churning out stories of a possible credit downgrade for the UK. The problems in Greece, while they do represent a potential embarrassment to for other euro zone economies only serve to underline the fear of a possible sterling downgrade, and in the general flight towards safe haven currencies seen over the last two weeks investors have discerned that sterling is riskier than the euro! If stock markets continue to fall, there is little doubt that the US dollar will rally further, but the sterling/euro debate is still very much to play for. The technical outlook for sterling versus the euro was boosted on Thursday as the market rallied off a key support level around 1.1325, erasing the week's losses to date. That could help us push on to new highs over the coming days, and with the QE question now out of the way we could see the sterling/euro uptrend resume. If we can continue to trade above 1.1325 and risk aversion diminishes there still exists a window of opportunity for the pound, at least until the next looming uncertainty appears on the horizon. The general election. If on the other hand the pound slips below that key support level, the technical outlook would be negative and we would be looking for a further decline to the January lows around 1.1050. 
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