Pound-Dollar Rate Takes Breather from Rally as Investors Mull Shifting Balance of Brexit Risks

-GBP/USD takes breather after Brexit-inspired rally to open week.
-GBP bears left vulnerable as Brexit risks begin to favour upside.
-But U.S. election debate has two-way implications for GBP/USD.

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  • GBP/USD spot rate at time of writing: 1.2847
  • Bank transfer rate (indicative guide): 1.2498-1.2588
  • FX specialist providers (indicative guide): 1.2655-1.2732
  • More information on FX specialist rates here 

The Pound-to-Dollar ratetook a breather from an earlier rally on Tuesday ahead of an eagerly-anticipated U.S. election debate, although the downside could be diminishing and Brexit risks shifting toward the upside for Sterling. 

Sterling has been boosted this week and last by a bout of caution among those betting against the British currency, but could have further to climb if if there's merit in the market's reduced pessimism on the outlook for the Brexit trade talks.

Minister for the Cabinet Office Michael Gove arrives in Brussels at the beginning of a critical period in the Brexit trade talks, and amid speculation suggesting the two sides are soon to begin drafting text of a trade accord. 

This is after the EU was reported Monday to have compromised on a demand that the UK concedes its red lines before work on trade terms begins.

“GBP maintains yesterday's gains, after the Times reported talks are improving, with Brussels expressing a readiness to work on the legal text, dropping its demand for both sides to reach broad agreement on outstanding areas of dispute. To the extent this is true, GBP could rise further on expectations a deal may be reached in time for the EU summit, although as big issues such as state aid remain to be resolved markets may be more sceptical of the newsflow,” says Parisha Saimbi, a strategist at BNP Paribas. 

Above: Pound Sterling performance against major currencies in last five trading days. Source: Pound Sterling Live.

This was right after government-friendly political media, with connections including former editorial staff inside the EU negotiations unit at 10 Downing Street, began to reflect on what life might be like under a compromise where the UK continues to adopt the EU’s rulebook on state aid.

Contemplation of a compromise came after government trade advisors expressed an openness to the idea of an “implementation period” that extends the status quo beyond December 31 if necessary. 

In other words, and in private, the government may not be as opposed to extending the transition period as it’s often made out. It could also be on the verge of a capitulation in the Brexit trade talks too. Any such outcome might force more investors to abandon earlier bearish wagers against Sterling and in the process, lift the Pound-to-Dollar rate.

"Brexit negotiations restart today and the bar for a positive surprise is low," says Michael Waugh-Bacchus, a spot FX trader at Deutsche Bank. "There have been many false dawns but mood music is soothing and both sides have indicated a willingness to compromise. I can see a scenario where progress is made, risk markets stabilise...Come on Boris, get Brexit done!."

Above: GBP/USD at hourly intervals, rallies after finding support on 38.2% Fibonacci retracement of March recovery trend.

“While the mood music is positive, it is not clear what has changed this week versus the past few weeks of Hard Brexit preparation,” says Jordan Rochester, a strategist at Nomura, who booked profits on an earlier bet against Sterling this week. “GBP tends to be more susceptible to these month end flows. If the US equity market continues to fall into month-end, we would expect risk on currencies such as GBP to underperform.” 

The analyst community is sceptical of the Pound’s sudden stabilisation however, given the many false dawns in past Brexit negotiations and the significant political differences that so-far still remain between the two side over access to the UK’s fishing grounds and the so-called level playing field agreement that includes but is not at all limited to just the controversial provisions on state aid. 

Political constraints on both sides may mean that any trade agreement requires at least the appearance of some form of compromise from each along the way, which would inevitably involve a carefully choreographed pantomime that could yet litter the path ahead of Sterling with fresh banana skins. 

There are many other risks that still lurk on Sterling’s path ahead too including a government that's increasingly trigger-happy with coronavirus-related restrictions but nonetheless, some analysts do also suspect that the British currency is at a turning point. 

Above: Pound-to-Dollar rate at daily intervals, follows S&P 500 (green line, left axis) higher after finding support on 38.2% Fibonacci retracement of March recovery trend and 200-day (black) moving-average. But will soon encounter resistance from its 55-day moving-average.

“With negotiations between the UK and Europe now seen at a critical moment, we look for evidence of a fresh near-term base. Indeed, with recent USD strength seen as corrective and with our broader view still long-term bearish, we continue to see bigger picture risk that GBPUSD may in fact in the process of constructing a long-term base,” says David Sneddon, head of technical analysis at Credit Suisse. “If we are correct (and there is still a long way to go to see this confirmed) this would be a technical/price sign that some form of positive deal is going to be achieved, with price action often “leading” the fundamentals. Our bias is for 1.2655 to remain a floor for a test of a cluster of resistances at 1.2967/1.3007, including the 55-day average.” 

The Pound has stabilised alongside the U.S. stock market it’s often followed in recent months and could yet be boosted further still if there are additional signs over the coming days that a Brexit trade agreement is in the pipeline.

However, Sterling will first have to navigate the first of three U.S. election debates, which could have an impact on the S&P 500 as well as positively-correlated currencies like Pound Sterling, the Euro and Australian Dollar. It gets underway in the early hours of Wednesday morning, pitting President Donald Trump against Joe Biden of the Democratic Party. 

Biden enters the debate with a healthy lead over the incumbent among pollsters, but his policy platform entails higher government spending and more onerous regulation that makes for a Dollar negative outcome in the event of an opposition election victory on November 03. 

“We know which way Wall Street is leaning, but there is not a clear sense that the result will materially impact the course of equity markets. As discussed last week, whilst a Democrat clean sweep – the Blue-nami – would mean higher taxes and regulation, other factors may play into the bulls' favour, notably the chance of a comprehensive fiscal package. More importantly, the global recovery from the pandemic, the Fed and earnings will be key drivers for equities after the election,” says Neil Wilson, chief market analyst at Markets.com. “The only thing the market wants is to get the election out of the way – the real danger to near-term valuations would be a long period of legal disputes post-election, which may mean price action continues to chop sideways within the range set in the second half of September.”

Above: Dollar Index shown at weekly intervals.