GBP/USD: Trading the U.K. Advanced GDP Report

Economic activity in the U.K. is likely to remain subdued in the second quarter, with economists forecasting a 0.3% contraction in GDP, and fears of a protracted downturn could weigh on the exchange rate as the nation faces its worst recession in over half a century.

[B][U]Trading the News: U.K. Retail Sales[/U][/B]

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[B][U]What’s Expected[/U][/B]

Time of release: [B]07/23/2009 09:30 GMT, 04:30 EST[/B]

Primary Pair Impact[B] : GBPUSD[/B]

Expected: 0.3%

Previous: -0.6%

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[B][U]Effect the U.K. Retail Sales report had over GBPUSD for the past 2 quarters[/U][/B]

[U]May 2008 [/U][U]U.K.[/U][U] Retail Sales[/U]

                                     Consumer   spending in the U.K. unexpectedly slipped 0.6% in May, with the annual rate   of consumption falling 1.6% from the previous year, and the data reinforces a   dour outlook for growth and inflation as households face a weakening labor   market paired with fears of a protracted downturn. A deeper look at the   report showed discretionary spending on clothing and footwear slumped 1.9%   from April, with sales at non-specialized stores falling 1.8%, while spending   on household goods advanced 1.6% during the month. Meanwhile, the Bank of   England continued to see a risk of a slower recovery as credit conditions   remain far from normal, with Governor Mervyn King stating that ‘banks’   ability to finance a sustainable recovery remains impaired by low levels of   equity capital.’ The comment suggests that the BoE may expand its asset   purchase program in the months ahead in an effort to shore up the ailing   economy.

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April 2008 U.K. Retail Sales[/U]

                                     Retail   sales in the U.K. jumped 0.9% in April, topping forecasts for a 0.5% rise,   and the data encourages an improved outlook for future growth as the   government takes unprecedented steps to shore up the economy. The breakdown   of the report showed sales at non-specialized stores increased 3.5% from   March, with demands for household goods rising 0.2%, while discretionary   spending on clothing and footwear slowed to 0.3% from 0.9% in the previous   month. At the same time, BoE Governor King said that he expects a ‘slow and   protracted’ recovery as the region faces its worst recession in over half a   century, and went onto say that ‘inflation is more likely to be below the   target than above.’ The dovish outlook held by the board suggests that the   MPC may expand its asset purchase program in order to jump-start the economy,   and is likely to hold the key rate the record-low for some time as growth and   inflation falter.

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What To Look For Before The Release[/B][B][/B]

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

                                     [B][U]Bullish   Scenario:[/U][/B]

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         If   we see substantially deeper available liquidity on the Bid side of the   market, this tells us that major price providers in the market are looking to   buy the Pound against the US Dollar. Considering that close to 60% of all FX   market volume is cleared through just six top banks, we see it prudent to be   on the same side of the trade as major institutions and will favor a bullish   bias on GBPUSD ahead of the data release.

                                   [B][U]Bearish Scenario:[/U][/B]
         
         If we see substantially deeper available liquidity on the Offer side of the   market, this tells us that major price providers in the market are looking to   sell the Pound against the US Dollar. Considering that close to 60% of all FX   market volume is cleared through just six top banks, we see it prudent to be   on the same side of the trade as major institutions and will favor a bearish   bias on GBPUSD ahead of the data release.

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How To Trade This Event Risk[/B]

Household spending in the U.K. is expected to rebound in the second-half of the year, with economists forecasting retail sales to rise 0.3% in June, and speculation for an economic recovery later this year could drive the British pound higher as growth prospects improve. At the same time, the final 1Q GDP reading reinforced a weakening outlook for Europe’s second largest economy as the growth rate plunged at an annual pace of 4.9% to mark the biggest decline since 1958, driven by a 13.2% drop in business investments, and firms may continue to scale back on production and employment as they face fading demands from home and abroad. A report by the National Statistics Office showed industrial production unexpectedly declined in May, with manufacturing outputs falling for the first time in three-months, while a separate report showed home equity withdrawals slumped at a record pace during the first quarter as banks continued to cut back on lending practices. Moreover, service-based activity, which accounts for nearly three-quarters of the economy, fell for the tenth month during April, while the International Labour Organization’s gauge for unemployment rose to 2.38M in May to mark the highest reading since 1995, and conditions are likely to get worse as BoE Deputy Governor Charles Bean anticipates the jobless rate to push higher throughout the near-term. Nevertheless, the National Institute of Economic and Social Research saw economic activity falling at a slower pace during the three-months though June, which encouraged an enhanced outlook for future growth, and the rebound in consumer confidence could support a rise in retail sales as policymakers take unprecedented steps to jump-start the ailing economy. Meanwhile, the Bank of England Minutes for the July policy meeting showed the MPC voted unanimously to hold the benchmark interest rate at the record-low of 0.50% and to maintain its GBP 125B asset purchase program, with the central bank anticipating a less severe drop in 2Q GDP than it had initially anticipated. In addition, the statement said that ‘the downside risks to gross domestic product in the near-term had probably diminished,’ with the BoE highlighting a lack of evidence to expand its asset purchases, and the improved outlook held by the MPC may continue to spur demands for the British pound as investors speculate the central bank to tighten policy over the next 12 months. Nevertheless, as risk trends continue to dictate price action in the currency market, the rebound in market sentiment may drive the GBP/USD higher over the near-term as participants move into higher risk/reward investments.

Trading the given event risk favors a bullish outlook for the Sterling as economists anticipate retail spending to increase in June, and price action following the data could set the stage for a long pound-dollar trade. Therefore, if sales rises 0.3% or greater during the month, we will look for a green, five-minute candle subsequent to the release to confirm a buy entry on two-lots of GBP/USD. Once these conditions are met, we will place our initial stop at the nearby swing low, or a reasonable distance taking volatility into account, and this risk will determine our first target. Our second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target.

On the other hand, tightening credit conditions paired with the slump in employment may lead households to cut back on consumption, and an unexpected drop in retail sales is likely to drag on the exchange rate as investors weigh the outlook for a sustainable recovery. As a result, if private spending unexpectedly falls for the second month and slips 0.2% or greater from May, we will favor a bearish forecast for Cable, and will follow the same strategy for a short pound-dollar trade as the long position mentioned above, just in reverse.

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