It is estimated that the global value of daily forex trading activity amounts to $5 trillion+.
This figure dwarfs the GDP of many countries around the world, yet this volume of currency trading takes place every day.
One of the most heavily traded currency pairs in the world is the GBP/USD a.k.a. the cable.
The name is derived from the trans-Atlantic cable that connected the UK and the US.
The top 5 most heavily traded currency pairs in the world are the EUR/USD, USD/JPY, GBP/USD, AUD/USD, and the USD/CHF.
In 2016, analysts found that the USD/EUR accounted for 23.1% of market share, the USD/JPY made up 17.8% of all trades, the GBP/USD made up 9.3%, the USD/AUD comprised 5.2%, and the USD/CAD constituted 4.3% of all currency pairs trading activity.
Clearly, the cable (GBP/USD) remains one of the favourites. Therefore, forex traders will do well to understand the internal dynamics that drive bullish and bearish positions on this currency pair.
Olsson Capital analyst, Hamish Cornwell has advocated for a greater understanding of the internal and external factors that drive currency pairs trading.
In the words of Cornwall:
‘We must be able to fathom the push and pull factors that drive traders towards one currency and away from another. The cable is a classic case in point. When the Fed raises rates and US employment data is positive, we see a rush to the USD. By the same token, when the UK presents favourable growth, steady inflation, and a positive prognosis on Brexit-related issues we see a shift towards sterling. Precisely how this balance affects the dynamic between the GBP and the USD is what forex trading is all about!’
Factors That Impact the Cable
Clearly, interest rate differentials between the US and the UK are a major determinant of its trading activity.
For example, the U.S. Federal Reserve Bank has been hiking rates by 25-basis points a pop since December 2015.
This represents a clear policy of quantitative tightening, and it has been enacted by the Fed to achieve the dual objectives of 2% inflation and full employment. The Fed is on track to achieving those objectives.
The current interest rate in the US is now 1.75%, the inflation rate is 2.4%, the GDP growth rate is 2.9%, and the unemployment rate is holding steady at 4.1%.
Combined, these elements present a picture of solid economic fundamentals.
However, this does not necessarily translate into a stronger USD. It must be borne in mind that when the dollar is strong, this negatively impacts dollar-denominated commodities like gold, crude oil, copper and the like.
A strong USD is also a disincentive to exporters. When goods cost more in foreign currency, foreign importers are less likely to purchase as much.
However, a strong USD encourages imports since they are relatively cheaper. The same principle holds true for GBP strength/weakness and imports/exports.
Across the Atlantic, the UK is slumbering in terms of GDP growth. It has an anaemic growth rate of just 0.4%, and while the unemployment rate is on par with that of the US at 4.2%, the inflation rate is markedly higher at 2.7%. The UK currently boasts of easy access to capital with an interest rate of just 0.5%.
The Bank of England has maintained that interest rate since 2017 and it held that rate steady by a vote of 7:2 on March 22, 2017 when the Monetary Policy Committee (MPC) decided to maintain the bank rates to encourage economic growth.
Recall that the UK is continually battling the Brexit demons, many of which have not yet come home to roost.
Based on these factors, there are several elements that determine whether traders go long or short on the cable.
It’s important to watch geopolitical events and follow the economic indicators to understand the market dynamics of forex trading.
