GBP/USD: Trading the Change in UK Jobless Claims

02/11/2009 11:30 am EST

Focus: FOREX

The British pound is likely to face increased selling pressures over the next 24 hours of trading as economists forecast jobless claims in the UK to rise another 88K in January, which would push the annual rate of unemployment to a nine-year high of 3.8%, up from 3.6% the previous month.


What's Expected

Time of release: 02/11/2009, 09:30 GMT (04:30 EST)
Primary Pair Impact: GBP/USD
Expected: 88K
Previous: 77.9K

Impact the UK Jobless Claims Change Has Had on GBP/USD Through the Past Two Months

December 2008 U.K. Jobless Claims Change
Claims for jobless benefits in the UK increased 77.9K in December to 1.16M, which is the highest level since 2000, and raised the annual rate of unemployment to 3.6% from 3.3% in the previous month. The data continues to foreshadow a deepening recession throughout the region as the labor market deteriorates at a record pace, and conditions are likely to only get worse as the European Commission forecasts the economy to contract 2.8% this year, which would be the lowest level of growth since 1946. As a result, the Bank of England is expected to ease policy further at next month's policy meeting in an effort to steer the economy out of the recession, and the extraordinary efforts taken on by policy makers should help to stem the downside risks for growth, but as the IMF forecasts a global recession for 2009, the outlook for improved growth remains bleak.

November 2008 UK Jobless Claims Change
Jobless claims in the UK rose at the fastest pace since 1991 as applications surged 75.7K in November to reach an eight-year high of 1.07M. The downturn in the labor market pushed the unemployment rate to a seven-year high of 3.3% from a revised reading of 3.1% in October, and conditions are likely to get worse as Europe's second largest economy faces its worst recession in over a decade. Despite the extraordinary efforts taken on by the Bank of England and the UK Treasury, growth prospects are likely to deteriorate further as financial uncertainties linger, and may lead the central bank to step up their efforts over the near term as policy makers expect the annual rate of growth to contract 1.3% next year. As a result, market participants expect the BOE to continue their easing cycle over the coming months, which is likely to weigh on the British pound going forward.

What to Look for Before the Release
In an effort to mitigate risk exposure, we will monitor market depth for GBP/USD ahead of the release. Our objective is to observe normal to high (or increasing) GBP/USD liquidity, which could help to shed some light on the market-moving potential of the release as well as the likely directional bias. Overall, increasing volume will telegraph likely momentum behind the move following the release. An imbalance in available liquidity on the bid versus the offer side of the market (or vice versa) will tell us what direction the major institutions are likely favoring ahead of the announcement. If the offer side sees deeper markets, this means banks are selling GBP/USD, and we will look to follow their lead and favor the short side. Alternatively, we will look for opportunities to go long if liquidity is deeper on the bid side. The absence of a clear imbalance (at least 2:1) or a weak uptick in volumes will signal a need for added confirmation before a trade is placed.

How to Trade This Event Risk |pagebreak|

The British pound is likely to face increased selling pressures over the next 24 hours of trading as economists forecast jobless claims in the UK to rise another 88K in January, which would push the annual rate of unemployment to a nine-year high of 3.8%, up from 3.6% the previous month. Fading demands from the global economy paired with financial uncertainties have certainly taken a toll on businesses throughout the region, and the labor market is likely to deteriorate further over the coming months as firms continue to cut back on production and employment in an effort to reduce costs. As a result of the economic downturn in the global economy, manufacturing outputs fell for ten consecutive months during 2008, marking its worst slump in nearly three decades, and the outlook for improved growth remains bleak as the European Commission forecasts Europe's second largest economy to face its worst recession since 1946. The advanced GDP reading for the fourth quarter showed that the UK economy contracted another 1.5% after falling 0.6% in the previous quarter, which lowered the annual rate of growth to -1.8% from 0.3% in the previous quarter, and the fundamental outlook continues to foreshadow a deepening recession throughout the region as the International Monetary Fund projects a global recession for 2009. Moreover, consumer confidence fell to a record low in January as the nationwide index slipped to 40 from a revised reading of 48 in the previous month, and as households become increasingly pessimistic towards the economy, growth prospects are likely to weaken further as domestic demands falter. Nevertheless, the Bank of England took further steps to stimulate the ailing economy this month as the MPC lowered the benchmark interest by 50bp to 1.00%, which is the lowest level in the central bank's history, and policy makers are likely to adopt quantitative easing in the months ahead in an effort to soften the landing of the economy. However, as price growth falls at a record pace, mounting fears for deflation could weigh on the central bank's ability to maintain their dual mandate to ensure price stability and foster economic growth, which could stoke a bearish outlook for the British pound going forward.

Expectations for a weakening labor market clearly favors a bearish sterling trade for the given event risk, but as we saw from the previous release, an enhanced labor reading could spark a rally in the pound/dollar. Therefore, if jobless claims rise less than expected (below 78K), we will look for a green, five-minute candle following the release to confirm a long position on two lots of GBP/USD. Once these conditions are met, we will place our initial stop at the nearby swing high (or reasonable distance) and this risk will determine our first target. Our second target will be based on our discretion, and to preserve our profits, we will move the stop on the second lot to break even once the first trade reaches its target.

Conversely, as signs of a deepening recession continue to emerge throughout the region, a dismal labor report would certainly favor a bearish forecast for the pound following the release. As a result, an inline print or a rise of more than 88.0K in jobless claims will set the stage for a short pound trade, and we will follow the same strategy for a short pound/dollar position as the long trade mentioned above, just in reverse.

By David Song of DailyFX.com

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