GBPUSD: can the recovery continue?

LThe next 48 hours could provide some potentially explosive events for this pair. First up, we get the FOMC meeting later today (check out our preview HERE) then we get the Scottish referendum result, which we are expecting at approx. 0700 BST on Friday morning.

Is a sterling crisis waiting in the wings?

Looking at the referendum first, a yes vote could trigger a decline back to 1.50 in this pair, while a win for the no camp could see it get back to 1.6600. Due to the uncertainty surrounding this referendum and the potential for Scottish independence, we think that the larger market reaction could come on the back of a yes vote, while a no vote could see an initial knee-jerk move higher in the pound before it starts to fade. The extent of upside for GBPUSD on Friday could depend on the margin of victory for the no camp. If they win by only a narrow margin, as we expect, then GBPUSD upside could be limited.

The BOE vs. the FOMC

In the very short term the direction for this pair could be dependent on the BOE vs. the FOMC. The pound is higher today after another strong labour market report, and signs that wage growth is, finally, starting to pick up. The market ignored the fact that the hawks on the Bank of England who started to vote for a rate hike last month didn’t manage to lure any other members to their hawkish fold, and instead concentrated on the news on slightly larger pay packets. This has helped GBPUSD to rise 100 pips today.

However, already the market is hesitating to push this pair any higher. GBPUSD’s rally has stalled around 1.6348 - the 50% retracement of the latest sell off that started on 2nd September. The big risk is the Fed’s fear factor. Will Janet Yellen sound more hawkish than usual during her post –FOMC decision press conference later on this evening?

A hawkish Yellen could trigger a rebound in the dollar, which could weigh on GBPUSD sending it back to 1.6205 – the tankan line on the daily Ichimoku cloud, and potentially back to 1.6052 – the low from 10th September.

In contrast, some of the contrarians out there expect Yellen to stick to her dovish mantra, which could boost the pound and send it back to 1.6644 – the high from 1st September, as the market starts to re-price the prospect of the BOE hiking at an earlier date than the Fed.

As you can see in figure 1 below, the spread between UK and US 2-year bond yields has started to widen again, and GBPUSD may need to play catch up. A dovish Yellen this evening could add to upward pressure on this spread and drag GBPUSD higher with it.

However, sterling’s performance this week is not as simple as the BOE vs. the FOMC. If Scotland votes yes it could cause a crisis for the pound, even with our better wage data for August. So keep your hard hats at the ready….

Takeaway:

• It’s a big 48 hours for the pound.

• If Scotland votes Yes tomorrow then it could trigger a sterling crisis on Friday.

• However, ahead of the vote the key event for sterling is the FOMC meeting.

• A more dovish than expected Yellen could trigger a rally in sterling, as the UK – US yield spread continues to widen and drag GBP along with it.

• Even if the pound rallies on the back of a dovish Yellen tonight, the ultimate direction for the pound could depend on the outcome of Thursday’s vote, so, FX traders, get your hard hats at the ready.