GBP/USD set to finish tumultuous 2020 on the front foot around 1.3650

GBP/USD is finishing the year on the front foot, with the pair crossing above the 1.3650 mark for the first time since May 2018 and printing highs during the European morning session in the 1.3680s. No particular news or theme is behind the upside, as sterling traders continue to juggle the themes of Covid-19 spread and lockdowns (will the UK go into national lockdown in January), vaccine distribution (how quickly can the UK achieve herd immunity) and Brexit (though a bare-bones deal has been agree and no deal avoided, what next for the UK’s service sector, for which nothing has yet been agreed).

Month, quarter and year-end portfolio flows appear to again be distorting the price action on the final trading day of the year; amid a lack of any catalysts, EUR is the G10’s underperforming currency, which is holding the Dollar Index flat (EUR/USD makes up 50% of the basket of USD major exchange rates that make up the index), though the USD is underperforming versus the majority of its major counterparts. GBP is one beneficiary of the weaker US dollar. Over the coming hours, trading conditions are likely to significantly die down given market participants leaving early for New Year’s Eve celebrations.

Sterling’s 2020…

It was a tumultuous year for pound sterling. After a strong finish to the year in 2019 on the back of a decisive Conservative general election victory that handed the party a 364 seat majority in Parliament (and avoided the market’s worst-case scenario of a Jeremy Corbyn led Labour Party victory), things quickly went south as the Covid-19 epidemic went global. By mid-March, GBP/USD has slumped more than 12% to more than multi-decade lows beneath 1.1500 and EUR/GBP had appreciated more than 10% to above 0.9400.

By the start of Q2 2020, GBP was well off these extreme levels, as the swift response from global fiscal and monetary authorities to the pandemic breathed life back into the more risk-sensitive such as GBP, AUD, NZD, CAD, the Scandis and Emerging Market FX. The subsequent wave of USD weakness that has carried through into the end of the year (driven the USD bearish combination of extraordinarily dovish Fed action, Joe Biden’s election victory and vaccine optimism) has lifted GBP/USD to the 1.3600 and into positive territory on the year. The pair looks to close out the year with gains of slightly more than 4.0%.

But Sterling has struggled to regain its poise versus the euro; EUR/GBP looks set to close out the year with gains of around 5.5% and EUR/GBP trading close to the 0.9000 level. Though the EU and UK managed to agree a bare-bones trade deal at the last minute and in doing so avoided the disastrous no-deal outcome, price action (i.e. the fact that EUR/GB remains elevated) suggests that markets are not overly impressed with the deal, that does not even yet cover access of the UK’s service sector (which accounts for 80% of GDP) to the EU market. Perhaps markets are of the view that the deal undermines the UK’s relatively economic standing versus the Eurozone.

The UK’s much faster rollout of Covid-19 vaccines will test this narrative; if the UK achieves herd immunity well ahead of the EU (perhaps as early as Q2 2020), the UK could be in for a period of relative outperformance versus the EU that might be bearish for EUR/GBP. It must not be forgotten, however, that another reason for EUR/GBP appreciation in 2020 was to do with the removal of EU breakup risk premia that was priced out when the bloc agreed on its next-generation Recovery Fund that would be funded by jointly issued EU debt. As these funds get dished out in 2021, though this might not immediately spur economic activity, it might spur continued improvements in confidence in the EU project’s long-term viability.