GBP/USD: Shoots up to test 200-D SMA; markets betting on a return to fair value and BoE rate hikes no matter what

  • GBP/USD makes an impressive extension to the upside, targetting a break on to the 1.31 handle having already pierced the 200-D SMA located at 1.3070 having scored a high of 1.3081. 

GBP/USD has rallied from a low of 1.2942 on fresh optimism over soft Brexit prospects as we get down to the last sand granules of the hourglass before the next key date on the timeline towards 'the scheduled' Article 50 Brexit date.

As it stands, the pound wants to rise no matter the odds of a soft Brexit or a hard Brexit. When casting minds back to Autumn of last year, the governor of the BoE, Mark Carney, suggested that, unlike after the referendum vote, rates may need to rise to curb inflation and that is at the crux of the pound's rise. 

According to reports of a briefing that Mr Carney gave to the cabinet in Sep 2018, a disorderly Brexit from the EU could represent a severe “contraction of supply” capacity in the UK economy. The BoE, therefore, may be of the mind to preempt weakness in sterling and out of hand inflation by raising interest rates to buffer the impact of rising import prices for UK business and ultimately, the consumer.  

Therefore, it would appear that such precautionary measures on a worst-case scenario could help buffer the pound, at least in the opinion of the markets at this stage, while a soft Brexit is set to put the pound back on track to move towards a fairer relative FX value. 

So where is sterling's fair value?

It is still reasonable to view $1.55 as a valid fair value and the centre of gravity for cable considering it was over $2.00 before the Global financial crisis and just before the Brexit shock it was on the $1.59 handle, around $1.55 at the time of the referendum that took place on 23 June 2016. If $1.31 is tested today, that would mean a 16% is yet to be priced in on a best-case scenario for the UK economy, whether in or out of the EU. 

Meanwhile, the day-to-day sentiment that is turning up the burners of December's 2018 correction, (fuelled by a turn in sentiment in the Fed and the greenback), is prospects of a no deal being taken off the table. This week's Brexit headlines have been centred around the next key date on the Brexit timeline as being January 29th when the UK's parliament will vote on PM May's "Plan B" amendments. The amendments could potentially allow Parliament to take over to prevent no deal or extension of Article 50 or a customs union. Moreover, the votes could even result in a call for a second referendum while  PM May continues to struggle to negotiate with Brussels on the Irish backstop. 

The UK sees more job gains and wages growth up to 3.4% y/y

There was also some promising UK jobs data released this week which brings back the prospects of a BoE rate hike, whether in or out of the EU and no matter what deal Britain concludes with the EU following the Brexit negotiations. 

Bulls, hold your horses! 

The real nuts and bolts to all of this are whether a no-deal Brexit can actually be taken off the table without revoking Article 50. The BoE is not going to raise rates until there is an outcome one way or another and that should keep a lid the pounds upside, for now, or even for the rest of this year - We will know more and be able to gauge timings better after the 29th Jan. 

"If other MPs cannot coalesce behind an alternative option, then even an extension of the Article 50 process would be insufficient to avoid an eventual no-deal exit. Moreover, as time passes and both the government and businesses continue with their no-deal preparations, the ultimate net cost of a no-deal exit would gradually decline, potentially making it more likely further down the line,"

analysts at Standard Chartered explained. 

Elsewhere, for the rest of the week, the same market drivers remain in play and it is all boiling down to the headlines surrounding the US government shutdown, Davos and US/China trade relations.

GBP/USD levels

On the wide, analysts at Commerzbank cite initial support as the near term uptrend at 1.2838:

"We regard the recent move to 1.2444, charted in January, as the end of the down move". As the price tests the 200-D SMA, the analysts say that above here would re-target the July, September and October highs at 1.3258/1.3363. "Dips will find support at the 55 day ma at 1.2773 and 1.2669/62, the August low. Only below 1.2444/25 targets the 78.6% retracement at 1.2109."

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