Pound-to-Dollar Week Ahead: Grasping for Support amid Noxious Cocktail of Risks

- GBP/USD rolls over edge of precipice as Brexit, U.S.-China storm gathers.

- GBP cedes 1.2163 after decisive losses on summit of March-April rebound. 

- Eyes Fibonacci support at 1.2030, 1.1883, 1.1675 ahead of 1.1491, 1.1409.

- 'No deal' risk, U.S.-China trade tensions, economic data in focus this week.

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- GBP/USD spot at time of writing: 1.2104
- Bank transfer rates (indicative): 1.1811-1.1896
- FX specialist rates (indicative):  1.1954-1.2027 >> More information

The Pound-to-Dollar rate went over the edge of a technical precipice in time for the Friday close last week, setting the British currency up for even further losses in the weeks ahead, although the scale of the decline and a nearby support level could see the British currency attempt to stabilise in the coming days.

Sterling fell more than two percent to 1.2104 against the Dollar last week and suffered heavy losses against most other major currencies as investor risk appetite wained and Brexit negotiators sounded the alarm again on a lack of progress in trade talks between the UK and EU ahead of an important deadline. This came as relations between the U.S.-China deteriorated, with the two sides exchanging harsh words and trade threats late last week, potentially undermining the prospects of a global economic recovery.

Friday's losses mean Sterling did not benefit from the typical bout of profit-taking that might otherwise have ensued ahead of the weekend, despite slipping steadily through the week, and with the exchange rate now near the 50% Fibonacci support level around 1.2030 it might attempt to stabilise early in the new week. However, last week's price action took the Pound-to-Dollar rate over the edge of a technical precipice around 1.2163 in time for Friday's close, which sets it up for further declines in the weeks ahead. 

Weakness came amid a Dollar rebound that was egged on by Federal Reserve Chairman Jerome Powell when he dismissed the idea of the bank resorting to a negative interest rate policy. New hostilities between the U.S. and China was also in the mix too, with Dollar demand undeterred by a steep and much larger-than-expected fall in April's U.S. retail sales revealed Friday.

"GBP/USD has closed below the 1.2247 21st April low and yesterday sold off to the April low at 1.2163. A drop below there will refocus attention on 1.1491, the 2016 low, and also the March low at 1.1409," says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank. "Fibonacci support found on route lies at 1.2030/1.1883/1.1675."

Jones and her technical analyst colleague Axel Rudolph are sellers of the Pound-Dollar rate from 1.24 and are targeting 1.21 and 1.1850 short-term, although they also look for a retest of the March lows at 1.1409 ahead of a possible fall to a fresh multidecade low at 1.0463 in the next three months or so. That latter target is just less than 14% below Friday's market price and so implies substantial downside for the exchange rate in the short term. 

Above: Pound-to-Dollar rate closes below 1.2163, eyes 50% Fibonacci retracement of March-April rebound at 1.2030.

"GBPUSD is poised to weaken—and perhaps in a meaningful way. April/May price action has seen Cable capped right on the 200-day MA twice and the current pressure on the intervening low (1.2252) suggests a double top signal is about to be triggered (implying around 400 ticks of downside potential and putting the GBP on course for a test of the mid 1.18s)," says Juan Manuel Herrera, a strategist at Scotiabank in a Thursday research note. 

The Pound-to-Dollar rate fell beneath the all-important April low of 1.2163 on Friday and if the market closes below there this weekend then it would put the 50% Fibonacci retracement of the March rebound, located around 1.2030, in the pipeline ahead of even further losses over subsequent days and weeks. 

"UK and EU negotiators are once again at an impasse over the future trading relationship, and neither side appears willing to give much ground at this stage. Our economists do not expect the UK to request an extension to the Transition Period, which under current legislation would need to happen by July 1. Given this familiar combination of an approaching deadline and intransigent positions, and the relative calm in markets allowing investors to take a slightly longer view, we expect Brexit concerns will continue to weigh on Sterling in the weeks ahead," says Zach Pandl, global co-head of FX strategy at Goldman Sachs. 

Last week's Brexit talks confirmed deadlock between London and Brussels following incompatible opening gambits from both sides, with the impassse widely expected to weigh further on the Pound in the weeks ahead as the June deadline for the requesting an extension to the transition approaches. 

Goldman's Pandl says this is a soft deadline that does not necessarily preclude approval of a request for an extension that comes in the second half of the year.

"Both sides could still agree to extend the Transition Period in the second half of the year. We expect markets to give considerable weight to this possibility, at least for now, and therefore continue to price a much smaller cliff edge around the July deadline. Looking further ahead, if UK negotiators continue to pursue a less-bespoke trading arrangement with the EU, markets will need to reassess the amount of currency adjustment required," Pandl says in a research note.

The official deadline for agreeing future preferential trade relations or defaulting to a relationship governed by World Trade Organization terms is December 31, although arguably the June 30 is important too because Prime Minister Boris Johnson has previously said "the Government will need to decide whether the UK’s attention should move away from negotiations and focus solely on continuing domestic preparations to exit the transition period in an orderly fashion," should the substantial body of a deal not be in shape before then. David Frost said Friday; "We very much need a change in EU approach for the next Round beginning on 1 June. In order to facilitate those discussions, we intend to make public all the UK draft legal texts during next week so that the EU's member states and interested observers can see our approach in detail."

Above: Pound-Dollar rate shown at weekly intervals alongside U.S. S&P 500 stock index.

Absent a request for a transition extension, which the government says it won't make, the market could soon begin to fret about something like a 'no deal' Brexit again and the last time it did that the Pound-to-Dollar rate fell below 1.20. This level has already been broken once amid the bearish price action of 2020 and is now key to whether the British currency sets new multi-decade lows like it did back in March. Some say it won't sustain a fall below there for long.

"We do not expect the UK government to soften their hardline approach at the current juncture despite COVID-19 disruption. The best outcome for the GBP is of course an extension but that looks less likely and as each day passes, we expect the markets to focus on this risk more. In these circumstances, we expect the GBP to continue to underperform in the nearterm. Cable is set to retest the 1.2000-level although any break below could prove short-lived based on experience from September 2019 and March 2020," says Lee Hardman, a currency analyst at MUFG.

Brexit will be a heavy weight around the ankles of Sterling in the weeks ahead but there are no further talks scheduled until June 01, which might leave the Pound taking cues from the ebb and flow of investor risk appetite as well as implications of key economic data over the course of the week. Trade tensions between the U.S. and China will be key to the broader mood in global markets, as well as incoming government disclosures on the number of new coronavirus infections in economies that are reopening following 'lockdown' periods aimed at stemming the advance of the pneumonia-inducing disease.

"While most believed US rhetoric/action against China could escalate closer to the November election (no earlier than 3Q), a few felt escalation was more imminent (over the coming month). The rationale was "saving the stock market" in the US was difficult and in any case would not help politically at a time of record job losses, so the need to deflect blame could be acute and sooner than expected," says Adarsh Sinha, a Hong-Kong based strategist at BofA Global Research. "Last week's reports that retaliatory measures are being considered by the US administration suggest this escalation could happen sooner rather than later. But much depends upon the sustainability of the Phase One trade agreement from January." 

Both trade tensions and the prospect of a second wave of coronavirus infections in reopening economies can put at risk the fledgling global economic recovery that began with the easing of 'lockdown' measures in Europe and the U.S., which would be bad for risk assets including stocks and Sterling.

"Tensions between the US and China are flaring up again, with President Trump threatening to ‘cut off the whole relationship’. Brexit negations are struggling, to say the least, and the German court ruling on the ECB’s quantitative easing program reveals how political pressures are building in other areas, as well. This comes at a time when equity markets seem to be consolidating in the wake of a massive stimulus-driven rally," says Jeroen Blokland, a portfolio manager at Robeco, a buy-side fund house with €171bn (£151bn) under management in 2019. "With the global economy still struggling to recover and forward earnings looking lofty, this increases the risk of a renewed downturn in equities – something I believe should be taken into account for multi-asset portfolio." 

Above: Pound-Dollar rate suffers decisive losses on the summit of the March-to-April rebound. Turned away from new highs.

Trade tensions can stoke fears for the global economy and a stronger greenback, which means they're a net-negative for the Pound-to-Dollar rate, although it's their impact on other risk assets like stock markets that could be of more significance for Sterling given the strong positive correlation between the exchange rate and the U.S. S&P 500 stock index. Many say that index has recovered too far and too fast from its March declines, leaving it vulnerable to setbacks that could easily be felt by Sterling. 

However, and with international investor sentiment aside, economic data due out over the coming days will also be important for the mood around the British currency.  March jobs data is due out on Tuesday ahead of IHS Markit PMI figures for May on Thursday and retail sales figures for April on Friday.

Consensus is looking for the unemployment rate to remain at 4.4% for March, but disclosures from the Department for Work and Pensions suggest the unemployment rate was tracking 6.6% at the end of March, following one week of 'lockdown'. It's thought to have risen even further since, likely into the double-digits in April, and there's reason to think it could go on rising for some time and potentially even after the coronavirus has been contained. 

Markets will look on Thursday to see if the April lows observed in IHS Markit PMI surveys of the services, manufacturing and constructions sectors remains intact. Meanwhile, Friday's fall in retail sales figures for the month of April will provide investors with more insight on the likely scale of damage done to the economy by the coronavirus and the 'lockdown' used to contain it.