Play the election with sterling-kiwi

EVERY poll putting the Liberal Democrats on a par with the Conservatives seems to result in sterling sinking a little lower. But with the effect of a hung parliament on the pound difficult to quantify, there are still plenty of foreign exchange traders who think there’s room for sterling to bounce even if we don’t get a clear-cut majority.

However, it has been difficult for traders who are relatively positive on the pound to find a sterling pair with a clear direction. The recent strength in the US dollar has seen cable lose ground over the past few months while euro-sterling has been choppy. Thankfully, therefore, RBS’s technical analysts Tom Pelc and William Moore have plugged the gap with a long sterling-New Zealand dollar strategy, which they think will see a long-term appreciation.

RBS says that this is potentially a “year maker” trade and argue “the brave should enter before the election while hung parliament risks are still at their zenith”.

There are also solid fundamental reasons behind this trade. First, hung parliament fears in Britain may well be overdone and we could therefore see a rebound post-election. And second, the governor of the Reserve Bank of New Zealand has been trying to talk down the long-term attractiveness of the kiwi, which has been at times a carry currency thanks to relatively high interest rates of 2.5 per cent.

Sterling-kiwi might have slumped dramatically last summer but the pace of decline has since slowed – it has only lost 2.3 per cent so far this year. There is a good chance that the pair could see a rebound back towards NZ$2.4916.

“We have witnessed major rebounds from the levels where the market sits currently and this is occurring at a time when sterling is showing signs of recovery from its big sell-off against some of the other major currencies,” they say.

This is for three reasons. First, the pair’s long-term head and shoulders pattern, which stretches back as far as the early 1990s, has reached its target of NZ$2.1505. The neckline was tested back in May 2006 without a subsequent break lower and the level is expected to hold again.

Second, looking at the monthly candlesticks, April’s has the potential to be a “shaven bottom” – ie, where the market started the month at the low, which implies that selling momentum is waning. Third, the slow stochastic oscillator – a technical analysis tool that smoothes and measures the momentum in the market – is now showing the market as overbought at the current price level.

Therefore, the strategy is to go long now with a stop placed at NZ$2.0750 on the basis that this sits just below the previous major low of NZ$2.0756 in the early 1980s. Initially, you should target NZ$2.2750, which sits on the 200-day moving average and is also the 23.6 per cent Fibonacci retracement of the March 2009 high to the March 2010 low. The 50 per cent retracement is NZ$2.4916.

The combination of the fundamentals and technicals makes this a hard trade to beat for sterling bulls, who are desperately looking for a pair to play out their views.