Pound not at the mercy of Brexit negotiations; Look at correlations to trade the GBP
Brexit on focus...
Looking at the 12-month performance comparative chart above, the GBP/USD has been a standout underperformer versus other major pairings. But how many traders have installed a short position pre-Brexit and are still riding on profits? Probably few, despite having had the chance. We advised on the magnitude of the event on several occasions:
- GBP/USD Forecast 2016. 'Brexit fears could weigh over Sterling' – Omkar Godbole, FXStreet | Dec 23 2015
- 'There's potential for a British Pound collapse in 2016' – Martin Armstrong, FXStreet Interview | Jan 04 2016
- GBP/USD Forecast 2017: Expect yet another murky year for Cable – Haresh Menghani, FXStreet | Dec 22 2016
Today, as many experts highlight, Brexit and the Article 50 triggering is a market mover for the Pound:
- 'The Article 50 is triggered; the UK has officially sent its demand to leave the European Union [...]' - Ipek Ozkardeskaya
- 'Traders are nervous about today’s Article 50 triggering that inspired recent strong sell-off (cable is down around 1.5% from Tuesday’s opening until now)' - Slobodan Drvenica
- 'Sentiment remains firmly bearish towards the Pound moving forward and the potential resurgence of hard Brexit fears could ensure price weakness becomes a recurrent theme' - Lukman Otunuga
As far as the near-term outlook is concerned, though, I would like to withdraw your attention –just for a moment– from the high profile news from the UK or Eurozone regarding the Brexit negotiations, and reassess where the Cable stands in terms of price action and structure.
... but there is another way to look at the price behavior
Correlation studies confirm the decoupling of the GBP with other core currencies on a long-term basis, in line with the above performance comparative. Only the CAD shows less sympathy than the GBP in aligning with its peers.
Zooming in on a daily basis, the same studies suggest the GBP is not that reluctant to follow other FX pairs.
The message is clear: as enticing at it may look to adhere to this price erosion –which by the way is not a Brexit result; the GBPUSD has been printing lower highs since the 60s– there is much more to extract from this pair if you pay attention to the interconnectedness of all FX pairs and their fractal similarities.
A Correlation coefficient shows how the GBP/USD is at times at the mercy of EUR moves, as it may be reacting to JPY or USD flows. Right now, studies show the JPY and USD are the ones dictating the structure. Notice the high correlations to some pairs: 80% positive correlated to the EURUSD, 96% and 93% negative to the USDJPY and USD/CHF respectively. Should have been the Sterling the one shaking the tree in the FX arena, we would see a higher correlation to other GBP pairs, which is not the case. EUR/GBP and GBP/JPY are 54% and 37% negatively correlated, which explains the case.
I recommend you to bookmark FXStreet's Correlations page for your future reference. It will help you to detect the relationships between currencies and understand the big picture.
Author
Gonçalo Moreira, CMT
Independent Analyst
As a trader in the foreign exchange market since 2005, Gonçalo Moreira honed his analytic and strategic skills through the Chartered Market Technician (CMT) designation.
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