GBP/USD - Recovery Forecast

The pound to dollar exchange rate (GBPUSD) is expected to benefit from signs that the longer-term uptrend in the USD is starting to stall.

“The evidence required for an exit was delivered this week as the dollar fell sharply across the board, bringing to an end, at least for now, the dollar rally.” – Phil Seaton @ LS Trader.

I reported at the end of last week that there was an increasing sentiment shift towards the theory that the dollar will only continue to deliver gains.

The thinking over at Morgan Stanley is that the ability of US economic data to continue delivering the required positive surprises is starting to become constrained.

As such, the sensitivity of the dollar to disappointments have increased.

Add to this the extreme positioning in favour of the dollar and we see the market is biased against further gains owing to its technical structure.

The downtrend in the pound dollar exchange rate (GBPUSD) could therefore be ending, in the near-term at least.

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Calling a Pause in the Trend

One of the most reliable strategies for considering direction in currencies is observing and following established trends.

Phil Seaton at LS Trader has built a living out of following trends and he notes warning signs on the months-long GBPUSD collapse.

“Although there is no question that sentiment for the dollar and against the Euro is at historical extremes, the same has been true for the past couple of months, but no reversal has been seen. A turn in both markets is clearly due...we will exit on evidence of a reversal,” Seaton told clients a week ago.  

In this week’s briefing he confirms, “The evidence required for an exit was delivered this week as the dollar fell sharply across the board, bringing to an end, at least for now, the dollar rally.”

While there is the potential for a break in the pound dollar downtrend it must be stressed that the longer-term picture does favour the USD.

This complicates issues for those watching the market as it suggests getting timing right is where challenges lie:

“The longer-term focus is still very much dollar bullish, but a period of weeks or even a few months of dollar weakness, correcting some of the recent larger rally, may be due.

“In fact, the recent rally in the dollar index was 27%, which in terms of percentage gains, is the second largest in the dollar’s history. In spite of the reversal, the LS Trader system banked huge profits from the short Euro and long dollar index trades, which amounted to 1857 pips from the two trades combined.

It is also worth pointing out that the market is restructuring to more sustainable pro-USD levels following the shake-up seen in recent days.

“The USD has pulled back post the FOMC and it is hard to see what will drive a move today out of recent ranges. The weak side is probably still for further USD weakness due to positioning, although the USD long has been paired back,” say Lloyds Bank Research.

Declines to 1.42 Forecast

So where will the pound sterling end up now?

Ultimately we agree with those in the market that are still advocating for further declines.

We qualify this view by pointing out that the rate of decline, and the extent of the decline, should be limited.

Analyst Luc Luyet at Swissquote says:

“Overall, the evolution of the British pound should now be more influenced by the weak UK inflation outlook than by the robust growth data.

“As a result, we see further downside for the sterling: GBP/USD is expected to decline towards its strong support at 1.4231 (May 2010 low).”

The inflation data that was released on Tuesday proved to be a negative for the sterling exchange rate complex as it confirms that the inflationary pressures required to prompt the Bank of England into raising interest rates just do not exist.

When the Bank of England hints to us that it is back on a hawkish path (look for pro-rate rise votes in the MPC) will we become confident in calling a resumption of GBP strength.

We would expect this data to ensure that any recoveries in the pound - dollar rate remain capped.

Sideways trading below the 1.50 rate of exchange could well become entrenched in coming weeks.