FX this Week: How to play the fading pound

Short GBPUSD

Over the previous week we looked to buy GBP by selling EURGBP, a strategy that worked. But for this week, we suspect that this GBP move is overextended and prefer fading further GBP strength by selling GBPUSD as the recent rally in GBP is getting overdone versus the USD. 

Much of the rally was driven by the follow through higher after the Conservative victory at the general election and a few good numbers out of the UK, particularly the stellar retail sales report this week. 

But the move looks overextended and in a relatively quiet data week, this could favour consolidation – especially as our longer term outlook for GBP is turning more negative. Watch out for the Thursday UK Q1 GDP release. 

Trading stance: Shorting GBPUSD as long as it continues to close below 1.5700 with stops above 1.5750 and adding on selloffs below 1.5550 for a test back toward 1.5300 or lower.

USDCHF call options

This is a repeat of previous week’s discussion on the potential for CHF downside assuming some kind of deal between Greece and its negotiators is struck over the next couple of weeks. If anything, announcements over previous week from Greece suggest that the time frame for a deal is quite short and June 5 might even be a hard deadline. 

Some traders might prefer expressing a view through EURCHF rather than USDCHF. Again, as there is significant risk that we are reading the situation wrongly, options allow taking a position without risking more than the premium used to purchase the option. 

Trading stance: Buy USDCHF call options for the 1-month or 2-month time frame – or both, and at two different strike prices – one that is closer, say 0.9500, and one that it more aggressive, perhaps 0.9700 (and the latter for a slightly longer tenor- two, or even three months).

EURJPY downside

The Bank of Japan upgraded its rhetoric on the economy at its meeting this week and is clearly in no hurry to add to its stimulus programme in the near future. With risk appetite stabilising and bond yields doing the same after the European Central Bank this week touted a “front-loading” of its quantitative easing programme ahead of the summer, the market may look to get back into the euro carry trade and sell the euro broadly. 

The combination of central bank signals points lower for EURJPY and the recent bearish reversal may follow through lower. 

Trading stance: Consider shorting rallies if EURJPY remains below 136.00 (and EURUSD remains below 1.1300 as there is a strong positive correlation between the two pairs) or consider 2-week puts perhaps 100 pips out of the money. The major technical target over the this week or two is the top of the Ichimoku cloud.

Selling AUD

This is a repeat theme from the previous week, and one that saw reasonable success, as AUDUSD faded back from a high above 0.8150 the previous week to a low below 0.7900 this week. The focus remains lower for AUD on downside risks from the assessment of Australia amidst a backdrop of weak Chinese data and an Reserve Bank of Australia hostile to any appreciation of the currency. There are only minor data releases from Australia this week. 

Trading stance: Consider AUDCAD shorts as long as that pair trades below the 200-day moving average (almost touched over the previous week just above 0.9750 – though beware of the Bank of Canada meeting on Wednesday) and AUDUSD downside remains the focus as long as we trade below 0.8000 on closing levels, with a possible pickup in the downside on breaks below 0.7800 toward the sub-0.7550 lows.

Wildcard: USDJPY upside breakout

The attempts by USDJPY to move out of the range have been frustrated since the tops and bottoms of the range were established way back in December, and the range has only gotten narrower – now between 118.50 and 121.50/122.00. 

We got close to breaking higher this week, but a breakout is only to be believed if it is actually seen as there is the risk that we repeat last year’s epic bout of tight range trading that lasted some eight months before the range was broken in August. 

A breakout may have to wait for the May US data cycle, but if the pair does break higher, we would prefer to be on board, as it doesn’t feel like the market is positioned for such a move and there might be a lot of “catch-up” trading as traders crowd to get involved in a new trend.