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Where next for the sterling rollercoaster?

Mar 30, 2020
What a difference one week makes. From the collapse of the majors to a big turnaround, the speed and volatility of FX moves has been breath-taking at times. This is none more so than in GBP and cable especially, which has at least managed to put Brexit in the shade.

To put some of this into context, cable fell 4.8% after the Brexit referendum in June 2016 whilst it rose 6.8% last week, after falls of over 5% in each of the previous two weeks. It seems the dollar has moved faster and deeper relative to its ascent than other risk appetite measures and GBP has whipsawed with it.

Dollar funding pressures

The well-known ‘dash for cash’ period we experienced for a couple of weeks ago saw the pound collapse to its lowest level on record against the currencies of the UK’s major trading partners. Sterling’s broad effective exchange rate was weaker than at any time during the Brexit process, the GFC and even the UK’s ejection from the European Exchange Rate Mechanism in 1992. Funding pressures took hold of currency markets as extremely poor levels of liquidity saw a surge in demand for USDs.

3 reasons for a pounding

It is important to briefly run through a few broader issues which hurt GBP initially and may do so going forward. Firstly, the elevated UK current account deficit means sterling will be exposed when there is a liquidity crunch. The UK has ongoing funding needs, and this is especially the case when the UK ranks last amongst all the other G10 countries in the size of its deficit.

Secondly, valuation remains an issue. If GBP traded only on the basis of yield spreads compared to the US and Germany, its fair value would be much higher, above 1.30. However, in today’s environment, we have still not seen extremely weak valuations, with the lows last week not being more than one and a half standard deviations versus the undervaluation for the other majors.

Finally, Brexit issues still do matter as the pound has suffered a structural decline with the Government’s inflexible position hampering its currency. This is likely to remain a constant background negative noise for GBP going forward. The timeframe for reaching a comprehensive deal looked tight even before the virus outbreak so an agreement looks highly unlikely, with the risk of a no trade deal Brexit denting the scale of GBP’s upside. Of course, a change of heart from the government would change this scenario.

Near-term global trends

GBP will be dominated by what is happening with risk sentiment in the short term. The latest Fed gesture has caused a decline of the dollar and with it an aggressive unwinding of sterling shorts. With sterling volatility remaining near the levels last seen since the referendum, and given the risk-averse mood in markets, we should expect choppy two-way trading to continue. Record prints in US jobless numbers will no doubt impact as well in cable. 1.2550/80 is the next resistance zone, before a confluence of indicators just below 1.27. Support comes in at the 50% retracement level from the recent high to below 1.15 at 1.2308 which sits just above the 21-day moving average.

Technical long-term low?

With cable hitting 30-year lows last week, the impressive rebound does potentially look quite constructive further out. The monthly close will be significant as a bullish hammer candle may act as a basis for confirmation that a major bottom is in place.

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