The Pound-Dollar Week Ahead: Breaking Higher on Charts but CNY Stocks, Coronavirus to Set Agenda

- GBP/USD charts point toward an extension of current rally.

- As key levels overcome after BoE leaves rates unchanged.

- GBP in upside break from consolidation pattern on charts.

- But cratering CNY stocks may spook global markets Monday.

- But more USD strength is ahead amid coronavirus fallout. 

- And GBP bond yields are elevated, may be vulnerable.

- Coronavirus uncertainty could sideline traders, lift volatility.

- Market to mull eventual policy response from China et al.

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- GBP/USD Spot rate: 1.3206, up 1.01% last week

- Indicative bank rates for transfers: 1.2844-1.2936

- Transfer specialist indicative rates: 1.3008-1.3087 >> Find Out More About This Rate

The Pound was the best performing major currency last week and is tipped by technical analysts to advance on the Dollar over the coming days, although fundamental risks include a likely Monday collapse in Chinese stock markets and elevated British bond yields that might be due a correction. 

Pound Sterling gained more than 1% over the Dollar last week after a Bank of England (BoE) decision to leave rates at 0.75% Thursday, in what turned out to be not nearly as close a call as markets had thought it would.

And it's now broken out to the upside from a symmetric triangle consolidation pattern on the charts, which is indicative of further gains ahead, while technical indicators are also pointing to a continued climb in the Pound-to-Dollar rate.

"GBP/USD saw a strong recovery from just ahead of its 1.2929 uptrend near term. While this holds it maintains scope for a deeper recovery to the 1.3285 Fibonacci retracement," says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank.

Above: Pound-to-Dollar rate shown at hourly intervals, alongside 2-year GB bond yield (orange).

Jones' studies take account of trends and momentum on the charts, rather than fundamental factors, but these signals could easily be overlooked by traders after Chinese stock markets reopen on Sunday following a week-long holiday. 

Sunday and Monday will be the first opportunities for locals to respond to last week's developments in the coronavirus outbreak, which has brought China to a standstill and threatens to cripple the economy in the first quarter.

The scale of the response will be telling of the level of panic within China and if declines in major equity benchmarks are more severe than the 6-10% falls indicated by proxies for Chinese assets this last week, it may spook investors. 

The Peoples' Bank of China (PBOC) has said it will inject 1.2 trillion yuan (£130 billion) of cash into the financial system via reverse-repurchase operations in a bid to ease any 'liquidity' or cash shortages. 

Above: Pound-to-Dollar rate shown at 4-hour intervals.

"The market is currently underpinned by the 1.2929 uptrend and the December low at 1.2908. Fibonacci resistance at 1.3285 is considered to be the last defence for the December high at 1.3515," Jones says. "Failure at 1.2908 would put the 200 day moving average at 1.2692 back on the plate."

Jones has a neutral outlook for the Pound-to-Dollar rate over the next three weeks but has suggested to clients that they attempt to buy the British currency around 1.3070, with a stop-loss placed down around 1.2925. 

Technicals studies may be pointing the Pound higher but these signals could easily be overlooked given the rapid spread of coronvirus inside China and elsewhere, which is the only story that matters for markets this week.

"We respect the sterling surge on the back of the BoE’s non-cut here but wonder how long it can continue if the backdrop remains pessimistic on coronavirus concerns," says John Hardy, head of FX strategy at Saxo Bank.

The Euro-Dollar rate was boosted Friday by a slump in emerging market currencies and there's a chance of a repeat performance this week, which might be positive for Sterling given its correlation with the Euro. 

However, the Pound doesn't always fare well during times of risk aversion and given the Dollar is the world's reserve currency and a so-called safe-haven there's also a chance the rug could be pulled out from beneath Sterling this week and without much warning. 

"The WHO officially declared the coronavirus as a PHEIC, or public health emergency of international concern," Hardy writes to Saxo clients. "We don’t take solace from the WHO press conference, which looked rather politically motivated to avoid being behind any disruption in economic activity rather than offering the best advice on how countries should deal with this disease."

Above: Pound-to-Dollar rate shown at daily intervals, breaking out from triangular consolidation pattern on charts.

Pound Sterling: What to Watch

The Pound outperformed last week owing to the BoE's decision to leave rates on hold which insulated Sterling from the fallout over coronovirus, although such protection is far from guaranteed in the week ahead. 

Last Thursday's BoE decision to leave Bank Rate unchanged at 0.75% has lifted short-term British bond yields in moves that could easily prove to be unsustainable, and any reversal of them could weigh on the Pound in a week that's devoid of major economic data releases from the UK.

The American two-year bond yield, which British yields tend to follow, fell notably last week and especially on Friday. Most other major economy yields also fell, leaving those of the UK government appearing incongruous. And there's plenty of reason for thinking that global yields will continue to fall in the week ahead, which could see Sterling and the London bond market playing catch-up. 

Above: 2-year GB bond yield shown at hourly intervals, alongside U.S. 2-year yield (blue). 

Any catch-up in UK yields could be exacerbated by the possible return of Chinese investors to the market after a week-long New Year holiday. Those investors have not yet had an opportunity to respond to a significant increase in the numbers of infected last week, not to mention the facts that China's economy has all-but ground to a standstill.

Some Chinese cities have turned to ghost towns over the last week and with the virus now in all of China's provinces, there is a chance that a multi-week period of quarantine, or self-isolation, awaits the entire country. That would have significant, unprecedented consequences for the economy.

China's National Health Commission updates with its latest declarations at 02:00 each morning while the UK government updates at 14:00 each day. These, as well as similar announcements from other governments around the world, will be the biggest drivers of markets in the week ahead.

However, the direction of China's Yuan will also be important for both the Euro and Sterling. And so too will the response of global investors to whatever happens in China's stock markets overnight.

Price action could expose a gap between the situation as it's been disclosed by the government, and Chinese peoples' perceptions of it. Proxies for Chinese assets have pointed to between a 6% and 10% fall in major equity benchmarks. A meaningfully larger decline could spook investors the world over.

The Dollar: What to Watch

The Dollar was the best performing major currency on an intraday basis Friday after climbing steadily through week as concerns about the spread of coronavirus lifted safe-haven assets and crushed risky assets, which is a trend that could continue in the days ahead. 

January's non-farm payrolls will be released at 13:30 Friday and expectations for jobs and wage growth would normally dominate trading leading up to the event, although this week is likely to see the agenda set by coronovirus developments and policymaker statements in relation to it.

Markets are looking for 160k jobs to have been created last month and hourly wage growth of 0.3% month-on-month, although the only story that'll matter at least initially is the coronavirus, Chinese efforts to contain it and investor perceptions of the likely implications for economies and markets the world over.

The Dollar benefits more often than not during times of crisis and the spread of a new coronavirus inside and outside of China now threatens to turn the February month into exactly that, a time of crisis. The new pneumonia-like disease has spread from Hubei province to all 30 other provinces within China, leading to panic among parts of the domestic population, self-isolation and panic buying of some important goods such as respiratory masks. 

Investors will be preoccupied Monday with the scale of losses seen in China's stock markets overnight as trading resumes following a week-long New Year holiday in which the number of officially declared infections rose from 4,515 at midnight on January 27 to 14,380 by midnight on February 01.

The number of "severe cases" has risen from 917 on January 27 to 2,110 while the number of declared fatalities has risen from 106 to 304. There are now 19,544 suspected cases, up from 6,973 

Above: 10-year major economy bond yields shown at hourly intervals. Yields falling as risk-aversion rises. 

Proxies for Chinese assets have pointed to between a 6% and 10% fall in equity benchmarks. A meaningfully larger fall could spook investors the world over.

This can only mean a stronger Dollar, Japanese Yen, Swiss Franc and Euro while potentially placing all other currencies at risk of losses to those majors. And that would be especially the case if price action in China's stock market does expose a gap between the situation as it's been disclosed by the government, and Chinese peoples' perceptions of it.

Already the expectation is for a severe hit to Chinese GDP in the first quarter, with a lesser impact on global growth.

City forecasters have so-far focused on assessing the impact the virus might have on Chinese and global growth this quarter, with a view to quantifying the likely implications for currencies and other asset prices. But governments and central banks could be forced into action a long time before first-quarter economic data ever reaches the market, with implications for exchange rates.

Some companies and households could face an acute shortage of cash-at-bank at the other end of a multi-week lay-up, or period of quarantine, which might necessitate a joint response from the government and central bank. And in the meantime, exchange rate volatility could increase if trading volumes fall due to uncertainty about the spread and overall implications of coronavirus.

The Peoples' Bank of China (PBOC) said at the weekend it will inject 1.2 trillion yuan (£130 billion) of cash into the financial system via reverse-repurchase operations in a bid to ease any 'liquidity' or cash shortages, although such stimulus doesn't automatically reach beyond the financial sector.

"The virus scare will (rationally) make market participants care less about “older” data," says Martin Enlund, chief FX strategist at Nordea Markets. "We fully understand if investors wish to stay away from more “virus-sensitive” currencies for now. This would include Asian currencies as travel bans and the like will weigh on activity in the region, and commodity currencies given how important China is for global demand."