GBP/USD Have we found the bottom?

1:13 AM

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Trading one currency against another is a matter of relative value. The Pound vs US Dollar has taken an absolute beating recently; can we conclude that the GBPUSD has reached the peak of its decline? The last time the currency pair reached this low was far back at 1985.

Are we experiencing the same thing? Or is this time different?

Taking inference from the book "This tine is different" by Carmen Reinhart and Kenneth Rogof; the phrase is worth contemplating. Let us consider the 1985 precedence and see if we can draw any inference from the two scenarios

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1985

For the UK the 1985 was the Thatcherism era where shoulder pads and Neoliberal policies dominated the United Kingdom policy.

The policies enacted by the "iron lady" increased unemployment and low income manufacturing jobs were fizzled out. Consequently, citizens were encouraged to purchase homes and invest in the stock market. The economy grew worse and as a last resort, companies like companies like British Telecom (1984), British Leyland (1984), Rolls-Royce (1987), and British Steel Corporation (1988) had to be taken over by the public sector. Things actually got a lot worse in the UK before they ultimately became better.

At that time, the economy in the US was an exact opposite when Ronald Reagan was in power; The GDP growth was good; unemployment at a record low and economy buoyant.

As of 1984, GDP growth in the UK was only 2.26% compared to 7.26% in the US. Pertaining Debt to GDP, US was just starting to mount up credit; rising from 38.4% to 41.7% while UK lowering from 43.5% to 43.4% is not enviable at all. As par unemployment, the US experienced a considerable decline from 7,6% to 7.2% while unemployment rate in the UK rises to record high of above 11%.

(numbers courtesy of FRED, Office of Nation Statistics(UK) and World Bank)

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Today

Fast forward to the present, the US economy seems to have limited prospect for improvement while at the same time, there is no reason to anticipate a decline. According to Ray Dalio analysis, we might have reached a state where we are "pushing on strings" a situation which he said an "asymmetrical risk to the downside" may likely occur.

GDP growth for both countries stand modestly at 2%-2.5% and unemployment for the two nations is relatively low - just above 5%. Debt to GDP ratio in the UK is relatively low compared to the US, standing at 84.4% while that of the US is at an all-time high above 100% mark.

The difference between the two giant economies can only be described as marginal; with the US having a higher downside risk due to GDP to debt ratio and elections for the POTUS just round the corner.

With Brexit coming to reality, it is no longer news that the UK is not a part of EU anymore. But, how it will be implemented is presently uncertain. Whether it will be a soft or hard Brexit remains a mystery.

Bear in mind that one of the reason why UK decided to leave the EU is to restrict other EU citizens from living and working in their country; this will negatively impact the stance of London as a financial hub in the sub region. Also, due to the fact that the services sector form the bulk part of the GDP, the country may be at the verge of decline to the old times.

The Brexit minister David Davies did promise during the negotiation for Britain exit that the British government will do whatever is required to uphold the good standing of the markets and financial sector.

Although Prime Minister Theresa May is in consent and would prefer to have the financial industry maintain a status quo; the possibility for other countries such as Germany taking over the role as the nucleus of the EU financial sector is quite tempting. One may be safe to assume that quite a number of countries will be interested in taking over the role erstwhile occupied by Britain.

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Conclusion

In event that a hard Brexit occurs, the major driving factors of the UK GDP will be negatively imparted and a recession with the potency decline leading to the 1985 economy disparity between the two countries may be inevitable.

The fact that we are heading back to the 1985 economic discrepancies between the US and the UK cannot be overruled. But till that event happens, it is more likely for us to see a recovery as the discrepancy of outlook is not as bleak as it was in 1985.

Interpreting the possible sequel of events in financial terms; one could expect the GBP/ USD pair to recover slightly at least until the terms of Brexit are made clear. Technical analysis shows the pair standing at around 1.22000 with a downside of 1.0600 (close to the 1985 lows). A recovery to 61.8% Fibonacci level will reach an upside of 1.3900.

Evidently, the risk/reward ratio of trading the currency pair is in favor of the bull


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