British Pound Looks Dangerously Overstretched - How do We Trade?

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British Pound Looks Dangerously Overstretched - How do We Trade?

Fundamental Forecast for the British Pound: Neutral

  • The GBPUSD looks overstretched as it surges but remains below major highs
  • UK Q3 GDP figures, Bank of England Minutes, and US labor data warns of sharp short-term swings
  • We’ll need a big surprise from economic data to force the GBPUSD out of its trading range

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The British Pound surged versus the downtrodden US Dollar and yet finished just short of year-to-date peaks. An ominous intraday reversal through Friday’s session warns that traders are not yet ready to push it to fresh peaks.

The week ahead promises important economic event risk from both the UK and US economies with Bank of England Meeting Minutes, UK Q3 GDP Growth numbers, and a long-overdue US Nonfarm Payrolls Report likely to force noteworthy volatility. Yet a sharp decline in forex market volatility prices/expectations suggests that huge price swings are relatively unlikely. How might we trade?

There seem to be toomany reasons to not go long the US Dollar at these levels (go short GBPUSD). Namely: a sharp drop in US bond yields/Fed interest rate expectations have forced the Dollar lower, while surges in the S&P 500 and quiet market conditions hurt the appeal of the safe-haven US currency. And yet going long the GBPUSD looks risky as the GBP looks dangerously overstretched below key October peaks. It might take major surprises in key event risk to force big GBPUSD moves.

Great Britain is the first G7 countryto report on Q3growth numbers, and the large range of analyst estimates suggests there’s a lot of uncertainty surrounding the release; sharp short-term GBP moves seem likely. BoE Minutes are comparatively less likely to force major waves as interest rate/monetary policy expectations look stable. But we can’t rule out a shift towards more dovish rhetoric given that the BoE meeting took place just as the US Government Shutdown entered its first full week. What of US labor market data?

The long-overdue release of September US NFPs results could spark large moves across US Dollar pairs—particularly as traders have aggressively scaled back bets on the future of the Federal Reserve “taper”. Why does this matter? The US Dollar surged on initial expectations that the Fed would taper its Quantitative Easing policies, but the sharp reversal in rate forecasts has led to Dollar weakness.

US Treasury Yields have given back anywhere between a third or half of the run-up they saw in the aftermath of the initial Taper bombshell, and any major surprises in NFP figures could force big moves in yields and the US Dollar.

There isn’t enough of a reason to go long GBPUSD here absent a convincing break above year-to-date peaks, but a short position looks similarly unattractive. In the absence of major fundamental surprises, the British currency could simply stick to its $1.5900-$1.6260 range of the past 30 days. - DR

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