GDP Data Undermines Recent Pound Strength

The post-summer rally in the British Pound, or GBP, is showing signs of stalling as the latest macroeconomic event risks have disappointed growth expectations and added an element of bearishness in general sentiment. Specifically, second-quarter U.K. GDP showed a sluggish 1.3% increase relative to the same period last year, and this equates to a moderate rise of 0.7% on a quarterly basis.

This relative weakness is putting pressure on the GBP, which posted losses against all of its most commonly traded counterparts after the release. And when we compare these figures to the growth rates on other major economies, this weakness creates a more bearish scenario for the CurrencyShares British Pound Sterling Trust , which tracks the value of the GBP, and favors U.S. counterparts like the PowerShares DB US Dollar Index Bullish .

On top of these disappointing GDP numbers, the U.K.'s first-quarter current account deficit increased at its fastest pace in nearly 60 years, while business investment posed another negative, falling 2.7% for the quarter and a much larger 8.5% on an annual basis. But what is most surprising is that this contradicts some of the more encouraging figures we have seen recently.

September retail sales rose at the fastest rate in 15 months, initially supporting the Bank of England's unanimous decision to leave stimulus programs on hold. But weakness in GDP growth and business investment suggests that the economic recovery is not progressing as well as the Bank of England believes. This also suggests that markets have been premature in assuming the central bank is in a position to begin shifting toward a more hawkish bias. 

Weak data makes things difficult for the Bank of England
Since March, the GBP has gained roughly 6% against its U.S. counterpart. But in order for this to continue, we will need to see some indication that the Bank of England has a timeline for when interest rates will rise in the U.K. Higher interest rates create a greater yield incentive for investors to hold a long-term position in a currency. And with theCurrencyShares British Pound Sterling Trust trading at elevated levels relative to its near-term average, the ETF is vulnerable to significant downside. 

The Bank of England has already made it clear that no increases in interest rates will be considered unless the national unemployment rate drops below 7%. This is still some ways off (the jobless rate now stands at 7.7%), and without consistent improvements in U.K. GDP growth, there is little reason to be bullish on assets that are highly correlated with the value of the currency.

Which currency ETF is poised for gains?
When looking at which currency ETF is best poised for gains, we have to look at the relative policy stance in the major central banks. The Bank of Japan has made it clear that it is still in the early stages of its own stimulus programs, and given little to no progress in reaching consumer inflation targets, central bank policy is unlikely to reverse anytime soon. As the Bank of Japan pumps more Yen into the system, the CurrencyShares Japanese Yen Trust will have no fundamental drivers for gains before the end of the year.

So what does all this mean? I spoke to Ann Gorenkova, currency analyst at the NordFX Company, who said this "really only leaves U.S. Dollar ETFs, given the relative positioning of the Federal Reserve in its easing programs." This argument is supported not only by the fact that we are already seeing voting members of the Federal Reserve allude to the possibility that stimulus-tapering will begin in October, but also by the strengthening rate of growth in the broader economy.

Second-quarter GDP growth in the U.S. was a steady 2.5%, while weekly jobless claims have fallen to their lowest levels since 2007. This strengthens the position of the Fed, as well as the relative prospects for ETFs like the PowerShares DB US Dollar Index Bullish.

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