Recovery In GBPUSD: Economic Fundamentals Adding Limited Support

Dec 08, 5:01 pm
Uk Inflation_BoE

GBPUSD Rebound Continues

Since the US elections at the beginning of November GBP has performed stronger against USD than the rest of the G10 pack. Despite what many analysts are saying it isn’t clear that any one factor has been responsible for the move which instead appears to be driven by a combination of elements which are likely to continue to support GBPUSD heading into the New Year.

Political Drivers Still Key

This week’s UK Supreme Court ruling generated a lot of noise and attention. One of the key elements that has supported GBP in recent weeks is the growing perception that the UK is moving away from a “Hard Brexit”. Indeed, simply the emergence of a bi-lateral dialogue between the administration and the remain campaign has helped foster an environment of support for GBPUSD.

Furthermore, the tone of the conversation between the two sides appears to have softened somewhat from the extremes of October. Attention is now shifting onto technicalities that could delay or soften Brexit. Last week, much of the political debate was focused on whether Article 127 might allow the UK to retain Single Market access even if Article 50 is triggered. So long as attention is focused on such scenarios, GBP is likely to remain supported.

The uncertain nature of the outlook alongside the contradicting nature of comments made by EU and UK officials makes it difficult to trade GBP based on political developments and means that political events cannot fully explain the current GBP rebound.  However, there are two potential political factors which could be exploited

  • Options markets are currently focused on March 2017 and are ignoring the idea of earlier risks. Although GBPUSD implied vols are elevated beyond the 3m level (March 2017 is the data when Article 50 is expected to be triggered) they are trading softer at the 1m and 2m level. This suggests that markets expect GBPUSD volatility to remain reasonably contained ahead of the March 2017 date. Given that the UK Supreme Court decision is expected in January there are clearly risks that GBPUSD could see heightened volatility in the first few weeks of the year.
  • The gradual effects of rising inflation, higher borrowing costs and a weaker pound have yet to take full effect on the UK public which could affect voter support for a hard Brexit. The market is potentially being complacent regarding the wider effect of changing economic conditions on both voter and political support for the administration’s Brexit strategy.

Economic Fundamentals Adding Limited Support

Another aspect which is key when considering GBP’s current move higher is that of economic fundamentals. Divergence among rate differentials has been an important driver of the moves in pairs such as USDJPY but is a little less clear when it comes to Sterling. EURGBP has indeed declined in line with the moves seen in rate differentials though since July this relationship appears to have weakened and indeed GBPUSD is moving in the opposite direction to that of rate differentials.

However, what could be contributing clearly from the side of economic fundamentals is UK data. UK data sets have continued to print strongly recently with the October Retail Sales rising to their highest levels of the year and PMI data sets continuing to show strength also. Indeed the Unemployment rate has now fallen to its lowest level in 11 years at 4.8%.

united-kingdom-unemployment-rate

However, whilst data sets have responded robustly in the wake of the UK’s Brexit referendum, these readings are no longer surprising as much as consensus estimates. Consequently, GBP is not benefiting as much from UK data points now as it was over the summer.

Positioning Shows Short Squeeze Underway

The best explanation for the current moves in Sterling comes from the positioning environment where a squeeze on extended short positions has been underway over recent weeks. However, once again this aspect cannot be seen as solely responsible for the moves as the latest positioning data shows shorts were put back on last week.

Technical Picture

The technical picture for GBPUSD shows that price continues to grind higher in a bullish channel and is approaching key resistance formed at the prior post-Brexit lows at 1.2794-1.2877. Bulls will be looking for a sustained breach of this level to signal further upside.

GBPUSDDaily

 

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With over 6 years’ experience analysing currency markets, James is now a well-known industry analyst focusing on price action trading and fundamental drivers. Beginning as a private retail trader, James developed a strong interest in understanding the fundamental aspect of the market before pursuing technical trading capabilities which he now uses to identify opportunities over a short-term horizon. Alongside his market experience, James is also IMC certified having achieved the qualification to help further his understanding not only of the markets but the industry as a whole. James has a strong interest in both fundamentals and technicals and uses both forms of analysis in generating and executing trade ideas, with trades generally lasting from a few hours to a few days.