Is GBP poised to move higher against the Euro?
Posted on: 29 January 2019 , by: Darren Sinden , category: Market Review
Trend: GBP gained despite a Brexit standoff, can it move higher versus a weaker Euro?
The Pound sterling has been appreciating during January against the grain. This has happened despite confusion around the Brexit process, an ever-shortening timeline and the possibility of a ‘no deal’ exit from the EU on the 29th of March.
Backed by bonds
The rates at which the UK government can borrow money from the markets are defined by the yield curve, which plots the varying cost of money over time frames that run between 1 and 30 years. This curve acts a barometer for sterling and sterling investments in the global capital markets.
The chart below plots the UK yield curve as it’s at the time of writing, and as it was one week, one month and one year ago.
What's interesting is that the medium to the long end of the curve (that’s between 5 and 30 years) is actually lower than it was a year ago (see the magenta and yellow lines below).
What this means is that the market is happy to lend money to the UK government at lower rates of interest than it demanded in January 2018, which sounds like a vote of confidence.
A deal on the horizon?
It seems the market senses a Brexit compromise is possible which avoids the worst case scenario of no deal and the confusion that a cliff edge exit would cause.
The underlying UK economy has performed well in recent months. Unemployment is falling to multi-decade lows with wages growing faster than inflation. GDP has been growing more quickly than that seen in France or Germany, in fact, lately, Germany hasn’t been growing at all.
The UK's economic surprise index which tracks beats or misses in macro data has bounced back firmly into the New Year, a stark contrast to the situation in Europe see below. This suggests that the UK and the pound could outperform Europe and the euro in 2019 if a Brexit solution can be found.
A bull trend in the offing
Sterling’s recent gains (+3.4% YTD) have shown up in my model, and the UK currency is within a whisper of breaking back to bull trend against the euro.
A weekly close below 0.8697 should be good enough to clinch it, but for the sake of a few ticks, we can wait for a close below or move through 0.8690 to be sure.
The door would then be open to moves to 0.8600 and 0.8562. However, there are deeper targets to look at beneath here, including 0.8390 an area the price hasn't been near since April 2017. I note that we traded down to 0.8652 and closed at 0.8653 in last Thursday’s session while the weekly close was at 0.8642. However, we’ve moved back towards 0.8690 in Monday's trade.
Proceed with caution
Trading sterling in the current climate is not without its risks. Markets can be poor judges of politics and political risk, so additional caution and sensible money management are required.
However, with even hard-line Brexiters such as Jacob Rees-Mogg indicating they might be persuaded to back PM Theresa May in a vote on a revised Brexit deal, there are reasons for optimism. Though Tuesday's debate and vote on the so-called Brexit plan b will confirm or deny that.
Euro sterling does not look oversold with RSI14 above 30 on its weekly chart as I write.
On the daily plot, the 20-day moving average has recently formed a dead cross with the 50-day line, confirming the downside momentum in the euro.
There’s also a sharp and continuing divergence between the trade-weighted euro and the sterling index, which also suggests that the path of least resistance in EURGBP is in a downward direction.
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