The Pending GBP/JPY Breakout

12/17/2008 2:08 pm EST

Focus: FOREX

From a fundamental perspective, the British pound is perhaps the most prominently exposed currency among the G10 through the outlook for growth and its financial health. In contrast, the Japanese yen is the consummate safe haven asset (though credit problems and recession are a plague in its own economy). This once high-flying carry trade has become one of the market's favorite pairs to deleverage and unwind. However, how far can the exchange rate drop before this pair is considered to be in line with its underlying perceptions? That is a question that has helped to keep GBP/JPY range bound over the past two weeks despite a clear shift in risk appetite. Going forward, rediscovering direction will be a contingent of how prevalent risk aversion is for the market. Should fear and panic rise, it will be easier to further extend this pair's declines. On the other hand, a speculation over the BOE's eventual stopping point with its own lending rates could be its own driver. If the MPC brings the UK to a zero interest rate policy regime, the reaction could be similar to what we have seen in the US dollar over the past week.

Chart

For price action, the chart shows spot at the bottom of a massive bear trend (that is still technically intact). However, there has been some level of consolidation in a loose range between 139.50 and 133.25. More important (and concise) seems to be resistance, which is backed up by the 20-day SMA and a confluence of Fibs. More influential, however, is the momentum of the long-term trend, which is the true driver of price action. Though this pair has a feeling of being overextended, the ultimate break will likely head in the same direction as the underlying trends in risk. Considering this pairs volatility, the historic lows it is cutting, and the position of the established trend, it is necessary to approach this eventual breakout with caution. A daily close outside of the aforementioned levels is essential, and stops should be placed on the opposite side of the current range. Obviously, this wide stop requires an adjustment to position size to allow for tolerable risk, and limits should attempt to secure a one-to-one objective (to risk) on the first target.

By John Kicklighter of DailyFX.com

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