Pound in Dying Phases of Multi-Year Downtrend Against US Dollar
The finalisation of an eight year recurring cycle supports the possibility the GBP to USD conversion may finally reach long-term lows within next 6-12 months.
- Pound to dollar exchange rate at 1.3113 on Wednesday 27th of July
- Lloyds Bank believe the GBP/USD is completing a major period of depreciation
- JP Morgan see bottom at 1.28, to be reached in September
- Westpac believe any broad-based US Dollar strength has its limits
- Deutsche Bank see up to 5% more USD upside in stock
Pound Sterling trades lower against the US Dollar ahead of the week's main event - the US Federal Reserve Open Market Committee meeting and mere days ahead of the August 4th Bank of England policy meeting.
Markets will be keen to ascertain whether the Fed is intent on raising interest rates in 2016, and what their views are concerning both the US and global economies.
Any hint of confidence will surely restart the Dollar's recent trend of appreciation; something that will place further downside pressure on the Pound / Dollar exchange rate which remains close to multi-year lows.
Those with an eye to the future should however note that while more near-term weakness is likely, substantial depreciation remains remote.
Lloyds Commercial Banking’s FX Analyst Robin Wilkin takes a step back from the day-to-day noise to view the bigger picture.
What Wilkin sees is the possibility that the GBP/USD pair is actually in the late phases of a multi-year down-trend, and with that, the possibility of rebirth and recovery can be seen on the horizon:
“Long term, the decline through the 2009 lows at 1.35 is viewed as the last phase in the bear trend that started back in 2007 from the 2.1160 highs.”
From here Lloyds expect a long-term bottoming to occur prior to the start of a longer-term up-phase:
“We favour a multi-month bottoming process. What isn’t clear yet is whether the current rebound from the 1.2800 region is the start of this process. A decline through there sees next major support in the 1.22-1.18 region.”
From long-term charts of GBP/USD, it is clear that the mid 1.30s constitute a significant support level which has seen price bottom several times over recent decades - most note worthily in 2001 and 2009.
Given the exchange rate has only fallen a little below those lows there is a possibility it could have posted its extreme lows already, at the July 6, 1.2796 lows.
Possible 8-year Cycle on GBP/USD Suggests Bottom in 2017
There exits compelling evidence of a roughly 8-year cycle in GBP/USD stretching back to 1969, and that the pair may be close to forming a bottom now.
The pair made significant bottoms in 1969, 1977, 1986, 1993, 2001, 2009 and now possibly again in 2017.
Apart from 1977-86 which was 9 years long, all the other cycles had a wave-length of 8-years.
Interestingly the cycle last bottomed in 2009, which would forecast the next bottom to occur 8 years on, in 2017 - or next year!
The pair made its lowest low in 1986 when it fell to 1.0438 lows.
The big question is will the cycle work again - and if it does, it must mean the pair will make a lower low in 2017, and therefore surpass the 1.2796 July lows.
Broker Daily FX’s FX Strstegist, Kristian Kerr, who spoke about the cycle in February 2016, compared the cycle bottoming now to that in the 90s as a result of the UK leaving the ERM.
He argued back in February that this suggested the bottom would not be much lower than the 1.35 lows of 2009:
“The other big takeaway I get from the chart is the clear resemblance of the current cycle with that of the one in the 1990’s. Both occurred after sharp declines in the pound because of crisis (ERM and GFC) and both had relatively minor recoveries of less than 30%. If GBP/USD continues to follow the 1990’s cyclical, analog it argues that the decline over the next year or two should not really extend more than a few big figures beyond the 2008 low around 1.3500.” Wrote Kerr.
JP Morgan see GBP/USD Bottom at 1.28
Analysts at the world's largest investment bank, JP Morgan, share the view that we are unlikely to go much lower, after forecasting a bottom in GBP/USD at 1.28, to occur in September of this year, before the start of a recovery higher again.
Although sterling is down almost 12% trade-weighted since the Brexit vote, it is up 3% from its early July lows and is unchanged month-do-date.
"Blame Bank of England communication, which seemed to guarantee a July 14th rate cut though instead deferred a decision until August 4th," says JP Morgan's John Normand in a note to clients. "We continue to expect the Bank to cut base rates to 0% this summer and to relaunch QE with £75bn of asset purchases, a view that is only partially priced in rates markets that see only less and more gradual easing (about 33bp of cuts by late 2017)."
Really easy money should be more toxi for the currency of a country such as the UK which is running a large external financing requirement.
This is a reference to the UK’s -6% of GDP current account deficit.
The GBP/USD target for September 2016 is set at 1.28 while EUR/GBP should have more momentum, to 0.89 by year-end.
Westpac: Sustained Dollar Strength to be Elusive
Adding to the sense that the US Dollar is unlikely to rise for an extended period is analyst Richard Franulovich at Westpac in Sydney.
Franulovich has released a note to clients on Wednesday dealing with the question of sustained Dollar strength in whcih he notes the support offered by US interest rate may be nearing a peak.
Studies of the US Dollar basket (a guage of USD strength based on the performance of the main Dollar-based pairs) shows that it is unlikely to advance beyond 100.
At the time of writing the basket is at 97.06.
"The USD index has scope for gains toward 100 but further meaningful sustained strength beyond that will likely prove elusive," says Franulovich.
This would imply that major pairs like EUR/USD and GBP/USD would both ultimately strengthen ensuring the broader basket remains below 100.
"The run-up in yield spreads in the USD’s favour may be nearing a peak and the fall in commodity prices does not seem like it will accelerate sharply," says Franulovich.
DXY weighted 2yr spreads currently sit at 100bp in the USD’s favour and studies conducted by Westpac shows that is about as strong as it typically gets.
All this suggests that while there is certainly some scope for the Dollar to strengthen, the limit is nearing.
Deutsche Bank: 5% More USD Upside
The Dollar has more fuel in its tanks argue Deutsche Bank who have released their latest views on the currency ahead of the July FOMC.
"The Fed could not have wished for more sanguine financial markets, or a more benign international events calendar and data backdrop. It begs the question: in a volatile world will 'the ducks' ever align so perfectly for a tightening, and will the Fed miss their opportunity?" notes analyst Alan Ruskin.
Even a dovish FOMC is likely to view the probability of a rate hike this year as significantly above what the market has priced argue Deutsche.
However, it is believed the Fed will be reluctant to signal far in advance of the September FOMC meeting, for fear that they are forced to retreat again in the face of unexpected data or events.
"It is expected that the USD could appreciate at least 5% on a broad trade weighted basis, before USD strength would again undermine US financial conditions to the point where it would impact Fed policy, in turn limiting USD strength," says Ruskin.