It's Time to Bet Against the Pound and Back the Dollar

The Bank of England announces the next round of quantitative easing (QE). At $75bn, it's 50% more than expected. Yet the pound rallies.

It doesn't make any sense, does it?

Well, no.

But then again, it kind of does.

I'll explain why today as I take a look at the pound and the dollar. And, what's more, I'll tell you where I think both are headed next.

The pound's rally won't last long

In just over a month from August to September the pound went from a respectable $1.66 to a rather embarrassing (if you're the chancellor) $1.53. That's quite a drop. Given such a furious fall, some kind of bounce was inevitable.

Rumours about the next bout of QE were already doing the rounds, so, as soon as the announcement came, the turnaround came. It was your classic 'buy the rumour, sell the news'. To be precise, from the pound's point of view, it was actually 'sell the rumour, buy the news', but you take my point.

Perhaps more significantly than this, however – after all it takes more than forex speculators to move a currency – was the fact that the stock market was rallying. When global stock markets rally, the pound rises. And vice versa. I made this observation back last month and we have already hit the $1.54 target I suggested in that article.

Now we're bouncing and, by close of play last night, the pound was hovering around the $1.57 mark.

That rally could well peter out here. Or we may go to a little bit above $1.60. I don't think we're headed much higher than that.

Here's my chart of the pound against the dollar since 1986. You sell if in the red zone, around $2. You buy it in the green zone, around $1.40, and in the amber zone around $1.65 it either meets resistance, or it finds support. For now the amber zone is an insuperable barrier.

To get through that barrier, I dare say we'll need some, if not all of: a stronger (ie more popular) government; higher interest rates; less debt; an economy in better shape; and a bull market in equities. Call me unrealistic, but I think we're a way off that.

More likely, the green zone beckons.

Back in August, I had a confirmed 'death cross' – an intermediate-term sell signal - on equities. This is a technical signal. When the 50-day moving average (the average price of the previous 50 days) crosses down through the 200-day moving average, which must also be sloping down, that is confirmation of an intermediate-term down trend. I all but have one on the pound: the only non-confirmation is that the 200-day is flat, not sloping down.

As a consequence I see this rally to $1.57 as nothing more than a counter-trend rally, a relief rally, and an opportunity to get out.

Good news for American tourists

The US dollar, however, looks like it's about to make a 'golden cross' – when the 50-day passes up through the 200 – which is an intermediate-term buy signal. The green line is the 200-day moving average. It is turning up. The red line is the 50-day, which is about to pass up through the 200.

(By the way for keen technical analysts, I find using the golden and death cross principle with the 21- and 55-day moving averages can work well. But here I'll keep it simple and stick with the longer-term 50 and 200).

Below is a chart of the US dollar's overall value since 1983. It experienced dramatic six to seven year falls between 1984 and 1991 and between 2002 and 2008, followed by a three to four year period of basing, when it was stuck in a range: 1991 to 1995 and 2008-11.

For now the dollar has found support in the low 70s. As the world rushes to pay down its debt, are we going to see a flight to the US dollar and a bull market like the one it enjoyed between 1995 and 2000? I think there's a good chance. That would surprise a few people.

Some visiting American and Canadian friends were moaning to me last week about how expensive London is. 'You try living here,' I told them. London will never be cheap, but, for them at least, it could be set to get a wee bit cheaper.

But not for us locals.