GBPUSD: Bearish Flag Breakdown Could Expose 10-Month Lows Near 1.60

Over a century ago, Charles Dow codified one of the first technical analysis frameworks, which eventually came to be known as Dow Theory. One of the basic tenets of the theory is that the market immediately discounts all new information as soon as it is released, a premise that Dow’s theory shares with the influential Efficient Market Hypothesis (EMH). In other words, the market is forward looking. Without getting into a philosophical debate about the merits of EMH or Dow Theory, it is clear that markets adjust to new information very quickly, bringing us to the GBPUSD.

Last week, traders were getting tied in knots about the upcoming Scottish Independence vote, but a brief glance at the rally in the GBPUSD would have revealed that the feared “yes” vote to independence was unlikely to emerge. Indeed, the pair rallied over 400 pips trough-to-peak in the two weeks leading into the referendum, clearly showing that traders were discounting the increasingly likely probability of a “no” vote.

However, once the “no” vote was confirmed on Friday, the GBPUSD actually fell as forward-looking traders had already fully discounted this outcome. Instead, investors turned their attention ahead to the uncertainty surrounding the UK’s new Devo Max reforms and the prospect of aggressively rising interest rates in the US. Traders who were reacting to the Scottish Independence vote were caught off guard, while traders who were proactively looking ahead were able to anticipate this move.

Moving forward, the developing divergence between strong economic data in the US (as evidenced by yesterday’s strong New Home Sales report) and deteriorating reports from the UK (including weak mortgage approvals, public sector net borrowing, and CBI sales data earlier this week) has some traders pondering whether the Fed may actually raise interest rates before the BOE. If the recent trend continues, expect to hear more of this possibility, accompanied by a commensurate a drop in GBPUSD.

Technical View: GBPUSD

As we go to press, GBPUSD is peeking below a bearish flag pattern that formed around the Scottish Independence referendum. For the uninitiated, this pattern simply shows a shallow countertrend move (< 38.2%) within the context of a strong downtrend. If confirmed by a close below the flag pattern, it suggests a resumption of the bearish trend and a possible move back down to the recent lows. The secondary indicators support this perspective: the “flag” move took the RSI indicator out of oversold territory, clearing the way for another potential move lower, while the recent “death cross” of the 50- and 200-day moving average suggests that the longer-term trend has shifted to the downside.

As long as the pair remains below 1.6400, more weakness is favored. To the downside, support may emerge at the 1.62 or 1.6100 round handles, but continued strong US data could take rates down to revisit the 10-month lows at 1.6060 or the 1.6000 round handle early next month. At this point, bulls would need to see a close above the 38.2% Fibonacci retracement at 1.6490 before the chart would look remotely constructive.