Grind Lower in GBP/USD to Continue

The British Pound is likely to continue working its way lower against the US Dollar we are told.

The Pound to Dollar exchange rate remains in familiar territory, in fact it has been seen around current levels of 1.2735 for two weeks now.

But recall the exchange rate was as high as 1.30 in mid-May which suggests a slow grind lower, suggesting the overall trend is lower even if we do see examples of near-term strength as is the case on June 27.

Recent softness comes as the repercussions of the June 8 election are seen to be impacting negatively on economic activity.

Data from YouGov and Cebr shows that Britain's messy election outcome and a weakening of the housing market have caused a sharp of loss of confidence among consumers. An index of consumer confidence produced by polling firm YouGov fell back to just above levels last seen just after last year's shock referendum decision to leave the European Union.

Concerning the outlook, we are told to expect GBP/USD to continue along its path lower.

“While the effective angle of descent here remains somewhat shallow at present GBP values are nonetheless continuing to work their way gradually lower following the prior rejection above 1.3000,” says technical analyst Lucy Lillicrap at Associated Foreign Exchange in London.

Those watching the market must keep an eye on the 1.2825 resistance level which “would probably argue a local bottom has been seen.”

However, “without additional basing evidence rally potential looks relatively limited in broad terms,” says the analyst.

Once support at the psychological 1.2500 level gives way selling pressure is expected to increase again with 1.2325 targeted next and 1.2100 thereafter as well.

It will take a more sustained move higher with a break of key resistance to convince the markets GBP/USD is turning positive once more.

“Only beyond the distant 1.3050 level frustrates this view,” says Lillicrap.

Summer Doldrums = Poor Risk/Reward on GBP/USD

Volatility in global foreign exchange markets has plummeted with the Pound trading tight ranges against the likes of the Dollar and Euro.

But it is not just the Pound that is sticking to recent ranges; the phenomenon is seen across the market.

“The summer solstice last week was marked appropriately by year-to-date lows in FX implied volatility,” says Kit Juckes at Societe Generale. “The summer doldrums have thus descended on the FX market. It is difficult to see what would stop the market being lulled into a deeper slumber in coming weeks.”

Juckes warns that the volatility decline cannot keep going on, “but it is a mug's game to speculate exactly when and why it will spike.”

In such conditions, traders are urged to stay out of the market.

“Cable is firmer but still essentially range-bound between 1.26/1.28; with spot essentially mid-range, there is little or no incentive for the market to get involved at this point as risk/reward considerations are sub-optimal. Look for ranges to hold for now,” says Shaun Osborne, Chief FX Strategist with Scotiabank in Toronto.

US Dollar too Cheap

The US Dollar is too cheap argue analysts at the world’s largest investment bank, JP Morgan. If correct, this suggests to us that a correction higher is possible.

Analysts have assessed the Dollar’s valuation against a host of major currencies and find that “the USD is materially cheap on rate-spread models, money market underpricing of the Fed is at an extreme, and US relative cyclical underperformance is reversing.

Foreign exchange markets in 2017 have been characterised by a falling US Dollar and strengthening emerging-market currencies; something that many in the exchange rate analysis community did not anticipate at the turn of the year.

“Despite the persistent USD weakness since the start of the year, a recovery phase in the second half is expected,” say JP Morgan in a note dated June 26.

However, the picture is muddied somewhat by analysts warning, “mixed signals suggest a broad-based rally could be difficult to achieve.”

The USD is said to be materially cheap on rate-spread models, money market underpricing of
the Fed is at an extreme, and US relative cyclical underperformance is reversing.

Last week JP Morgan sought to profit on a recovery in the Greenback by going ‘long’ on the DXY basket.

JP Morgan argue that Dollar weakness has stretched a bit too far, as pro-USD Trumponomic pricing positioning has been completely unwound.

The Dollar rallied with gusto following Trump’s victory as markets anticipated stronger economic growth stemming from the President-elect’s promise to cut taxes and increase government spending on infrastructure.

On signs Trump would struggle to deliver on these promises the Dollar retraced. However, JP Morgan argue that the markets are now pricing the Dollar at levels consistent with no Trump boost.

This is seen as unreasonable on the assumption that the President will be able to deliver something.

Further, the markets are seen as being to cautious in their assumptions on how many interest rates the Federal Reserve will deliver over coming months.

There is a risk that the Fed delivers more interest rates rises than expected, which will create a positive boost for the Dollar.

Analyst Hans Redeker at Morgan Stanley agrees that the Dollar is oversold.

The analyst told told clients mid-June that his team now believe USD weakness has gone too far and he is looking for a recovery.

“Within six months, markets have swung from being extremely upbeat on the USD to the opposite, but by now USD sentiment and positioning have gone to extreme levels, suggesting that a minor improvement in the fundamental outlook of the USD or a significant equity market decline could spark a significant USD upward reaction,” says Redeker.

It is the belief of the US investment bank that over recent weeks USD has decoupled from nominal interest rate differentials, suggesting that the importance of debt-related flows has eased relative to equity and other long-term asset flows.

“This is why the equity market evolution is determining the direction of the USD for now,” says Redeker.
Morgan Stanley have turned tactically bullish on USD and see negative sentiment and short positioning as extreme and a modest increase in the outlook could result in a significant USD appreciation.