Will the Big Pound Short Position Prove to be Correct?

Wednesday, 25th April 2013

Tomorrow at 9:30 a.m. we will find if the UK avoided slipping back into another recession, defined as two consecutive quarters of a contraction in the GDP. Last quarter, their GDP was a negative 0.3%. This quarter the average guess is a positive 0.1%, so there is very little margin for error. Looking at the futures market, speculators are convinced the pound is headed lower. In last week's COT report, the net speculative short position in the pound was 87.4K contracts of futures and delta adjusted optiyons. This compares to a short position 48.2K in the euro. The OI in the euro, however, is is much bigger, 264.2K contracts versus only 217K in the pound. This means the speculative short position in the pound is 40.3% of the total OI, and only 18.2% in the euro. With so many people on the short side of the pound, I question if a bearish number would have much effect on the market, and a bullish number might cause shorts to scramble. Recently, Chancellor of the Exchequer Osborne has been criticized by the big spending, antiausterity crowd. Slow economic growth in the UK has partially been the result of Osbourne's spending cuts, they claim. According to Allister Heath in this morning's Telegraph: "...the spending reductions are the good part of the overall austerity package; and the simplistic attack on Osborne for "cutting too much, too fast" has no basis in reality. To understand why, consider the facts. Last time I checked, total, real terms spending cuts of just 2.7pc spread over seven years is hardly the greatest of revolutions... It certainly is not the sort of change that causes an economy to stagnate for years." The IMF has joined the criticism of those opposed to the spending cuts in Britain. Sky News reports: "The IMF managing director warned that Britain's economic growth performance is "not particularly good", reinforcing suspicions that the fund will ask the Chancellor to moderate the severity and speed of his austerity plans. The fund's chief economist, Olivier Blanchard, was more forthright earlier this week, telling Sky News that Britain's economic policy plans were "playing with fire". Is it not curious that the IMF has singled out the UK policies for criticism, when closer to Lagarde's IMF French home, there have been no complaints? France has not balanced her budget since 1974, public spending is 56% of GDP, and last year the deficit was 4.8% of GDP. French taxes have been raised. As a consequence, venture capitalist and the wealthy are moving elsewhere. This is a mess waiting to make the headlines. There is increasing animosity between Britain and the Continent over Britain's refusal to join the single currency, and subjugate their policies to the dictates of Brussels and Frankfurt. The most recent example is the EU's proposed Financial Transaction tax. Britain rightly claims the tax would send business from London and Frankfurt to New York and Asia. Further it would harm the trade in European debt, and collect far less than projected.

In Britain, the agitation with the rules handed down by the Brussels elites grows. Each day a group called "Better Off Out" gives me unsolicited reasons, on my Facebook, why Britain should leave the EU. Recently, only a third of the Brits said the wished to remain in the EU - and 50% said they wanted to leave. PM Cameron has promised to win some of the power back from Brussels and offer a referendum whether to remain in the EU by 2017.

When we compare the pound with the euro, we may be looking at the lessor of two dirty shirts, but we are inclined to favor the pound. Part of this is a contrarian view. There are many unrewarded bears with short pound positions. There may not be favorable reason to favor the pound, but there are even fewer to like the euro. Consider today we had some resolution of the political void in Italy and the euro was not impressed. There are too many countries in the euro where too many things can go wrong.

We are inclined to trade the EURGBP (FXB, FXE) from the short side though we want to first see the GDP numbers tomorrow. Should the number be constructive this would remove the pressure on the Bank of England to further increase money supply and could be a set up for a return to the 83 area. As always, mind your money.