British Pound Recovers on Brexit Deal Progress after BOE Rate Cut Warning
Brexit Latest Talking Points:
- With the EU-UK Brexit negotiations ongoing and no certain path to an amicable resolution, the Bank of England has warned that it may cut rates soon. Rates markets, however, are not convinced: there is only a 37% chance of a 25-bps rate cut through August 2020.
- Signs of hope for a deal breakthrough emerged late on Wednesday: European Commission President Jean-Claude Juncker said that “we can have a deal…[a no-deal] would have catastrophic consequences.”
- Retail trader positioning suggests that GBPJPY and GBPUSD rates may rally further in the coming sessions.
It’s not a “Super Thursday,” but it sure feels like one. The September Bank of England policy meeting produced the dually surprising yet unsurprising remark from BOE Governor Mark Carney that the Monetary Policy Committee may need to cut interest rates thanks to the uncertainty around the US-China trade war and the outcome of Brexit. Rates markets, however, are not convinced: there is only a 37% chance of a 25-bps rate cut through August 2020.
The more important news on the day was the recent development that UK Prime Minister Boris Johnson has submitted to the European Union a framework of a deal that would allow the UK to leave the EU on October 31, 2019 as planned. This may not be a false start either.
Signs of hope for a deal breakthrough emerged on Wednesday when European Commission President Jean-Claude Juncker said that “I had a meeting with Boris Johnson that was rather positive. I think we can have a deal…I don’t like the idea of no-deal because I think this would have catastrophic consequences.”
It would thus follow that: if the BOE is considering cutting interest rates due to Brexit uncertainty; and Brexit uncertainty is dropping thanks to positive commentary from European Commission President Juncker; then the BOE may not be incentivized to cut rates as soon as they were otherwise indicating this morning. In the current environment of the “race to the bottom” among G10 currencies’ central banks, this may help provide further scope for Sterling rates to recover.
GBPUSD RATE TECHNICAL ANALYSIS: WEEKLY CHART (JUNE 2016 TO September 2019) (CHART 1)
The bullish outside engulfing bar in the first week of September was a sign that there existed greater upside potential; follow through to the topside last week saw GBPUSD rates break above the descending trendline from the May and June 2019 highs. Now, the weekly 21-EMA envelope is being tested as resistance, while weekly MACD has turned higher (albeit in bearish territory), while Slow Stochastics have pushed the median line into bullish territory. There are still technical reasons to expect GBPUSD rates to trend higher.
GBPUSD Rate Technical Analysis: Daily Chart (September 2018 to September 2019) (Chart 2)
In our last GBPUSD technical forecast update, it was noted that “A break above 1.2380/85 – a key band of support/resistance dating back to 2017, including the January 2019 Japanese Yen flash crash low and the July 2019 swing low – would suggest that the trend has indeed turned in a more reliable fashion.” To this end, GBPUSD rates have maintained their elevation through 1.2380/85 suggesting that a turn has indeed occurred; a low may be in place for GBPUSD barring a no-deal, hard Brexit.
With GBPUSD rates above the daily 8-, 13-, and 21-EMA envelope in bullish sequential order, Slow Stochastics in overbought territory, and daily MACD rising through its signal line into bullish territory, it still holds that the path of least resistance is to the topside. Only a close below the daily 8-EMA would suggest that the recent uptrend has been exhausted.
IG Client Sentiment Index: GBPUSD Rate Forecast (September 19, 2019) (Chart 3)
GBPUSD: Retail trader data shows 60.9% of traders are net-long with the ratio of traders long to short at 1.56 to 1. In fact, traders have remained net-long since May 6 when GBPUSD traded near 1.3096; price has moved 4.7% lower since then. The number of traders net-long is 0.6% lower than yesterday and 10.6% lower from last week, while the number of traders net-short is 0.5% higher than yesterday and 10.5% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests GBPUSD prices may continue to fall. Yet traders are less net-long than yesterday and compared with last week. Recent changes in sentiment warn that the current GBPUSD price trend may soon reverse higher despite the fact traders remain net-long.
GBPJPY Rate Technical Analysis: Weekly Chart (October 2016 to September 2019) (Chart 4)
At the start of September, GBPJPY rates established a bullish outside engulfing bar/key reversal on the weekly timeframe. Last week, there was follow through to the topside after breaking the downtrend from the May and July 2019 swing highs, with GBPJPY rates rising through all the way to the weekly 21-EMA in the process. Likewise, the decisive return back into the channel from the 2018 high suggests a near-term bottom has been established and there is greater scope for recovery.
GBPJPY Rate Technical Analysis: Daily Chart (August 2018 to September 2019) (Chart 5)
In our last GBPJPY technical forecast update, it was noted that “GBPJPY rates broke above 130.70 on Thursday, September 5, clearing out the descending trendline from the May and July 2019 swing highs in the process. Now that GBPJPY rates are comfortably above the daily 8-, 13-, and 21-EMA envelope, and that both daily MACD and Slow Stochastics have risen into bullish territory (the latter is overbought), it would stand to reason that the criteria for a short-term bottom have been met.”
In a sense, nothing has changed; the bullish momentum profile for GBPJPY rates persists. Key levels to the topside remain 135.92 (January 2019 Japanese Yen flash crash close) and 136.94 (61.8% retracement of the 2018 high/low range). It still holds that the call for a short-term bottoming effort would be invalidated on a return below 130.70.
IG Client Sentiment Index: GBPJPY Rate Forecast (September 19, 2019) (Chart 6)
GBPJPY: Retail trader data shows 57.1% of traders are net-long with the ratio of traders long to short at 1.33 to 1. In fact, traders have remained net-long since May 6 when GBPJPY traded near 146.67; price has moved 8.1% lower since then. The number of traders net-long is 3.4% lower than yesterday and 13.6% lower from last week, while the number of traders net-short is unchanged than yesterday and 11.2% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests GBPJPY prices may continue to fall. Yet traders are less net-long than yesterday and compared with last week. Recent changes in sentiment warn that the current GBPJPY price trend may soon reverse higher despite the fact traders remain net-long.
EURGBP Technical Analysis: Monthly Rate Chart (1994 to 2019) (Chart 7)
In our last EURGBP technical forecast update, it was noted that “thus far in September, EURGBP rates have continued to find follow through lower after the inverted hammer in August.” EURGBP rates hit a fresh weekly and monthly low just yesterday, and on the monthly timeframe, momentum is starting to shift to the downside. Monthly MACD is nearing a sell signal (albeit in bullish territory), while Slow Stochastics have already turned lower (in bullish territory as well).
EURGBP Technical Analysis: Daily Rate Chart (September 2018 to September 2019) (Chart 8)
There has been follow through to the downside below recent range support around 0.9016. EURGBP rates remain below the daily 8-, 13-, and 21-EMA in sequential bearish order. Daily MACD continues to trend lower in bearish territory, while Slow Stochastics are holding in oversold territory. Per the last EURGBP technical forecast update, it was noted that “a drop below the July 25 swing low at 0.8892 would suggest a deeper pullback is likely to occur.” With EURGBP trading at 0.8848 at the time of writing, the conditions are in place for more losses in the very near-term.
IG Client Sentiment Index: EURGBP Rate Forecast (September 19, 2019) (Chart 9)
EURGBP: Retail trader data shows 42.3% of traders are net-long with the ratio of traders short to long at 1.37 to 1. In fact, traders have remained net-short since May 9 when EURGBP traded near 0.8648; price has moved 2.3% higher since then. The number of traders net-long is 4.6% lower than yesterday and 23.7% higher from last week, while the number of traders net-short is unchanged than yesterday and 6.8% lower 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.
What Happens to the British Pound: No Deal, Hard Brexit
Under a no-deal, hard Brexit outcome, traders should expect further losses by the British Pound, with EURGBP likely to trade closer to parity (1.0000), GBPJPY could trade towards 120.00, while GBPUSD could fall towards 1.1000 during the first 12-months of a no-deal, hard Brexit (keeping in mind that the European Central Bank and Federal Reserve would likely cut interest rates to prevent Brexit shocks from impacting either the Eurozone or US economies too significantly, thereby capping potential gains by the Euro and the US Dollar versus the British Pound).
What Happens to the British Pound: No Deal, Hard Brexit + Scottish Exit
But this would not be the worst case scenario for the British Pound; in the event that Scotland holds a second independence referendum, it’s likely markets will be facing down the threat of disintegration of Great Britain as we know it. Under a no-deal, hard Brexit coupled with a Scottish vote to leave the UK, traders should expect EURGBP to climb towards 1.0500, GBPJPY to fall towards 112.50, and GBPUSD to drop closer to 1.0500.
What Happens to the British Pound: General Election
There is scope for a short-term recovery for the British Pound if it appears that a no-deal, hard Brexit is delayed. This could come in the form of a general election that replaces Brexit hardliner Boris Johnson as UK prime minister. The vote on Tuesday, September 3 should be watched closely to see if the UK parliament is able to retake control of its schedule and avoid prorogation. In the event of a delay in the Brexit process, EURGBP could fall back towards 0.8600, GBPJPY could trade towards 133.00, while GBPUSD could rise towards 1.2600
What Happens to the British Pound: Second Referendum
The only hope that the British Pound has for a significant recover is if Brexit is avoided altogether: after all, it will be impossible to replace the economic activity lost endured from leaving the EU, the world’s largest single market. In the event that the next UK prime minister has a change of heart and takes steps to avoid Brexit (e.g. a second referendum or withdrawing Article 50), EURGBP could fall back towards 0.8300, GBPJPY could rally back towards 145.00, and GBPUSD could climb back towards 1.4000; a full-scale recovery back to pre-June 2016 Brexit vote levels is highly unlikely in the immediate aftermath of the cancellation of Brexit.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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