GBP/USD Forecast: Buy the dip? DUP-related drop may precede a Brexit deal rally

"Faraway, so close" – The name of the hit song from Irish band U2 may be the best description to the state of Brexit talks – with Ireland in the spotlight and GBP/USD volatility skyrocketing. 

UK Prime Minister Boris Johnson is ramping up efforts to convince the Northern Irish Democratic Unionist Party (DUP) to support the upcoming Brexit deal. At the time of writing, the DUP is still unconvinced and therefore Britain has not given the green light to its interlocutors in Brussels. GBP/USD has dropped from a peak of 1.28 to below 1.27.

Talks continue in Brussels to hammer out more details, but the focus shifts to London. Efforts to convince the small party may include promises to invest more cash in the region. Apart from talks with DUP leader Arlene Foster and her colleagues, Johnson convenes his cabinet later today and is set to address the 1922 backbencher committee of his Conservative Party. Some of the hardliners – such as former Brexit Secretary David Davis – await the verdict from the DUP to makes their decision. Selling his Brexit deal is the name of the game today.

All scenarios are possible.

See Brexit: Five outcomes and GBP/USD reactions as a deal may become real

The contours of a deal, and why GBP/USD jumped

And what is this Brexit deal? No official papers have been published, but Johnson has reportedly agreed to practically keeping Northern Ireland in the EU's customs union – separating it from the rest of the UK.

The implications are: 

• It will allow an open border in the Emerald Isle as everybody desires.
• For the EU, it would preserve the integrity of the bloc's single market.
• For the PM, it would allow Britain to sign new trade agreements – a clean or a hard Brexit.
• The downside for the DUP is that this agreement would create a customs border in the Irish Sea – disuniting the union. 

For markets, certainty is preferred over uncertainty. Investors frown on this hard Brexit, prefer a soft Brexit and wish for it to be canceled altogether. However, a delay that would theoretically open the door to such options would also open the door to a no-deal Brexit. 

Overall, any deal is a good deal at this point, and that is why sterling surged on Tuesday.

Beyond Brexit

UK Consumer Price Index is set to show a small uptick in inflation, but there are reasons to doubt it. It is essential to note that sterling's response is dependent on the mood around Brexit talks.

See UK inflation preview: Downside surprise has higher chances and GBP/USD may struggle

US-Sino relations have soured once again. US lawmakers are advancing a law that would examine Hong Kong's preferred trade status following the protests there. China has responded angrily to this development. Moreover, Beijing has conditioned reaching $50 billion worth of Chinese purchases of US agrifoods on Washington's removal of tariffs. These developments have weighed on markets. 

US retail sales are set to shed light on the state of the US consumer – which has been driving the world's largest economy forward.

See US Retail Sales Preview: Stronger consumer sentiment may tilt consumption higher

Overall, Brexit headlines are set to dominate trading with brief breaks for other events. 

GBP/USD Technical Analysis

The Relative Strength Index on the four-hour chart is just above 70 – indicating overbought conditions – and implying an extension of the downside correction. Other indicators are pointing to further upside, with the 50 Simple Moving Average breaking above the 100 and 200 SMAs – a bullish sign. Upside momentum remains robust. 

Resistance awaits at 1.2735, which capped GBP/USD in June. The fresh peak of 1.28 is critical resistance. Beyond this line, we are back to levels that were last seen in the spring. These include1.2865, 1.291.2920, and 1.2990.

Support awaits at 1.2640, which worked as support in June, followed by September's peak of 1.2580, and then by the post-surge low of 1.2505.