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UK Bond Yields will Underpin GBP in the Weeks Ahead

UK Bond Yields will Underpin GBP in the Weeks Ahead

2018-02-13 11:30:00
Nick Cawley, Strategist
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Sterling Talking Points

- Short-dated UK bond yields near three-year highs, boosting GBP’s attraction.

- EUR/GBP may fall as UK headline inflation remains sticky.

Check out our new Trading Guides: they’re free and have been updated for the first quarter of 2018.

Interest-Rate Sensitive UK Bonds Warm to Bank of England Guidance.

The yield on the UK 2-year Gilt rose to 0.7%, close to its highest level in over two-years, as market expectations of a 0.25% UK interest rate hike in May continue to grow. This yield compares favorably – on a carry basis – to the -0.58% currently seen on the German 2-year Schatz, the Euro-Zone benchmark. The chart below shows the yield on the UK 2-year rising steadily since September last year when expectations that the UK will change its course on monetary policy – confirmed at last week’s hawkish Quarterly Inflation Report - and begin a tightening cycle began to be priced into the UK bond market.

UK 2-Year Bond Yield Chart Weekly Timeframe (January 2015 – February 13, 2018)

UK Bond Yields will Underpin GBP in the Weeks Ahead

EURGBP Nears Recent High; Brexit Continues to Cast a Shadow.

The latest EURGBP price chart shows the pair stuck in a range between 86.3000 and 89.300, both important Fibonacci levels. The likelihood is that the pair will remain in this range unless Brexitnegotiations/trade agreements break-down, making a hard Brexit more likely, a Sterling negative event. Recent commentary from EU Brexit negotiator Michel Barnier has not helped this by calling for the UK to be fined if they break EU rules during the transition period, while he added that this transition period is not a given unless the UK complies with EU rules and regulations. However, any positive Brexit news, and the additional carry of UK 2-year Gilts over German 2-year Schatzs, could see the pair fall to the bottom of the range fairly quickly.

EURGBP Price Chart Daily Timeframe (April 2017 – February 13, 2018)

UK Bond Yields will Underpin GBP in the Weeks Ahead

Chart by IG

Clients Net-Short of EURGBP.

IG Client Sentiment data show 32.6% of traders are net-long with the ratio of traders short to long at 2.07 to 1. In fact, traders have remained net-short since Feb 05 when EURGBP traded near 0.88692; price has moved 0.1% lower since then. The percentage of traders net-long is now its lowest since Aug 16 when EURGBP traded near 0.91345. The number of traders net-long is 15.9% higher than yesterday and 19.0% lower from last week, while the number of traders net-short is 36.3% higher than yesterday and 39.7% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EURGBP prices may continue to rise. Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EURGBP-bullish contrarian trading bias.

The Traits of Successful Traders and how to find the Number One Mistake Traders Make are just two of the topics covered in ourFree Trading Guides.

If you have questions or comments on this article, you can leave them in the section below, or you can contact the author via email at Nicholas.cawley@ig.com or via Twitter @nickcawley1.

--- Written by Nick Cawley, Analyst

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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