GBP/USD: Risk of trading close to the 1.25 area by the end of the year - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, explains that yesterday evening’s dive in GBP/USD may have been small in relation to the flash crash recorded in October, but the move was still surprisingly sharp give the liquidity that would have been present in US hours. 

Key Quotes

“Although the magnitude of last night’s move will have raised a lot of eyebrows, we would argue that cable’s fall back below the 1.30 level was less of a revelation.  In the past week or so there have been clear signs that the short-covering pressure that lifted cable from its early March levels was running out of steam.  Although cable is again testing the 1.30 levels this morning, assuming some stabilisation in the value of the USD, we continue to view rallies above this level as selling opportunities.”

“Going forward, concerns about slowing UK economic growth provide a poor backdrop for the pound.  That said, political uncertainty is likely to be the main reason why the market is likely to hold onto sizeable short GBP positions.  On April 18 when PM May announced the surprise general election, GBP/USD surged.  Many commentators linked this move with an alteration in market perceptions regarding the chances of either a hard or soft Brexit.  We are not convinced by these arguments.”

“Although currencies tends to react favourably to expectations of strong, liberal governments (which the June 8 election is likely to bring), we would argue that GBP’s recovery on the news of an election was significantly amplified by the fact that speculative short positions had recently reached record levels..  The reason that these negative bets had reached such extreme levels was the result of anxiety connected with Brexit.  Although there is still a lot of bad news priced into the pound, we expect that Brexit related uncertainty will weigh on the pound again in the coming months.”

“In the months between UK’s referendum on EU membership in June last year and May’s January 17 speech, the pound had shown a tendency to react positivity to news which favoured a soft Brexit.  On January 17 this year PM May had offered the reassurance of a plan.  However, she simultaneously put the UK economy on course for a hard Brexit.  May’s pledge on trade that ‘no deal is better than a bad deal’ was this week enshrined in the Conservative party manifesto.  Since trade talks are arguably the single most important part of the Brexit negotiations for the market, this is likely to be met with some alarm by investors.”

“Earlier this week the results of a CIPS survey found that 46% of European businesses expect to reduce their use of UK suppliers as a result of Brexit on fears of increased costs.  This is linked to the expectations that a fall back to WTO trade terms would bring large tariffs for sectors that include cars, dairy and pharmaceutical and nontariff restrictions for service sector.  Faced with the uncertainties connected with trade negotiations, we see risk of cable trading close to the USD1.25 area by the end of the year.”