Analyst Pick: Short EUR/GBP
Position: Short EUR/GBP
Entry: 0.8620 (below April 17 and 2018 low)
Stop: 0.8750 (above April 6 bearish outside engulfing bar)
Target 1: 0.8300 (July and December 2016, April 2017 lows)
Target 2: 0.7600 (June 2016 low)
Timeframe: Several months
The British Pound and the Euro couldn’t be having different years through the first three and a half months of 2018. To be frank, the Euro has been mostly a bore for traders thus far, with EUR/USD carving out a sideways range since the middle of January. But GBP/USD couldn’t be more different: it has been steadily climbing higher ever since the calendar turned. This may be yielding a longer-term opportunity in shorting EUR/GBP.
Central banks may be the driving force behind the different outcomes. Whereas the European Central Bank is very much in a holding pattern, the Bank of England has been leaning more and more towards raising rates at least once but perhaps twice this year. To wit: overnight index swaps are pricing in a meager 27% chance of a ECB rate hike by the end of 2018; meanwhile, OIS point to a 85% chance of the BOE hiking rates in May and a 49% chance of a second 25-bps hike by December.
The perception of political risk has also been a determining factor for the lack of movement in the Euro and the uptick in activity in Pound Sterling. Whereas 2017 was defined by deflating political risks in the Eurozone, nothing meaningfully good or bad is on the near-term horizon in 2018. Conversely, while concerns of a ‘hard Brexit’ proliferated throughout 2017, 2018 has been marked by significant optimism that the UK will head towards a ‘soft Brexit’ now that a two-year transition window has been established once Brexit officially takes place in March 2019.
Both the impact of speculation around central banks and the unwind of political risk are longer-term influences, and thus a longer-term perspective on a pair like EUR/GBP is required.
Price Chart 1: EUR/GBP Daily Timeframe (November 2015 to April 2018)
Price chart 1 (above) shows that a bearish rising wedge has been forming since November 2015. Typically, wedge patterns call for a return to their base; in this case, the terminal target for EUR/GBP may see the pair return back closer to 0.7000 over a multi-year time-horizon. Price action has been somewhat textbook: a topping pattern arises and breaks lower; there is a period of consolidation following the break; and now, we’re waiting for follow-through to the downside.
Price Chart 2: EUR/GBP Daily Timeframe (November 2015 to April 2018)
The time for the sideways consolidation in EUR/GBP may finally be coming to an end. EUR/GBP has been trading in a slight descending sideways channel going back to September 2017, but recently, a series of lower highs and lower lows have emerged. Indeed, looking at the daily MACD and Slow Stochastic readings, momentum has shifted to the downside as price has traded below the daily 21-EMA since March 30.
No doubt, given the relationship between price and time, shorting EUR/GBP will take a great deal of patience. In the near-term, we’ll be looking for a break below the April and 2018 lows overall to signal that the breakdown out of the sideways channel is legitimate, suggesting that a multi-month – and even a multi-year move – towards 0.7000 is beginning.
For now, focus should be on a return to the lows established near 0.8300 through 2016 and 2017. We'll be updating this analyst pick every few weeks as we monitor EUR/GBP for follow-through on the multi-year bearish rising wedge.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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