GBP: Cracks emerging - HSBC

GBP has proven remarkably resilient against the USD since it spiked higher in mid-April, but it has been flattered by the broader weakness of the USD, according to analysts at HSBC.

Key Quotes

“EUR-GBP, for example, has been mostly on a steady upward trajectory during this period. Our tactical view that the EUR rally may be due a period of consolidation has prompted us to take profit early on our long EUR-GBP position. But it also suggests that GBP-USD may be more vulnerable to the downside, so we now recommend selling GBP-USD.”

“We have long argued that the Brexit vote means GBP should be thought of in terms of political and structural drivers, but the market behaviour so far this year suggests others disagree. GBPUSD has traded close to the direction and level signalled by shifts in relative UK-US rate expectations, for example using Dec 18 3M interest rate futures contracts. There is no particular mispricing in GBP currently using this metric.” 

“However, we suspect this rate differential is set to continue its grind lower over the coming month, pointing to a weaker GBP-USD. It is interesting to note the shifting momentum in terms of UK growth expectations. Economists chopped their GDP forecasts for 2017 aggressively in the wake of the EU referendum outcome last year, excessively so as it turned out. So from the end of August 2016 through April 2017 we saw only upward revisions to those pessimistic 2017 GDP growth expectations. However, now we are seeing them move lower once again as challenges to consumption and investment become more apparent.”

“GBP-USD is at an interesting juncture technically, just holding above the 100-day MA. The 100day MA was also a persistent support level in June. If it succumbs to our expected shift in relative rate expectations it could open up a swift move towards 1.26.”

“Such a move would likely rejuvenate the notion that GBP is also suffering from political risk. The probability of a hard Brexit / no deal increases the longer there is little progress in the UK-EU negotiations. The next round of negotiations begins on 28 August. The UK is releasing position papers but it remains to be seen whether UK aspirations will be acceptable to the EU. One suggesting a customs union be retained for a transition period after Brexit has met a cool response. There are also continued signs of disagreement even within the UK government on the appropriate negotiating stance. The FX market may have pushed politics into the background, but it has not disappeared.”