British Pound Talking Points:
- GBP/USD was in a difficult spot earlier in September and the problem has continued to devolve.
- It’s a negative feedback type situation around the UK and the British Pound with a collapsing currency leading to surging bond yields which led to a BoE intervention effort that’s led to more currency collapse. It’s a painful feedback loop that hasn’t yet stopped.
- Is there hope on the horizon? And is this a problem that will be relegated to the UK, as it has similar hues to problems being seen in Europe and the United States.
- The current backdrop is messy as bonds and FX are screaming panic and meanwhile, US equities look relatively calm. I discussed this at-length in yesterday’s webinar.
- The analysis contained in article relies on price action and chart formations. To learn more about price action or chart patterns, check out our DailyFX Education section.
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The British Pound collapsed last week, or so we thought, only to open our platforms this week to see what a collapse in a major currency actually looked like. GBP/USD has set a fresh all-time-low and perhaps more disturbingly, in the days since, price hasn’t really rebounded much. Sellers are still hitting the pair and now there’s other dislocations that are taking place.
The UK is faced with a similar problem as Europe and the US with extreme inflation. All three Central Banks were rather calm as inflation built through much of last year but this year, as inflation continued to run-higher even after initial tightening efforts, worry started to show given that central bank efforts were not only unsuccessful but also appearing to bring on even more problems.
And there’s a very logical issue going on at the moment. As central banks warn of much more tightening ahead – that’s like hanging the sword of Damocles over the bond market. As rates go up – prices go down. And as prices go down and portfolios are marked to market, there’s an unpalatable amount of unrealized losses. So, if bond market participants know that a central bank is going to embark on a stern campaign of tightening, they know for a fact that the central bank will be working against their currently-held positions and this gives a lot of motive to sell.
Selling bonds – leads to higher rates. This was a known factor as central banks were doing QE but QE became so commonplace that the risks seemed non-existent. And now we’re seeing the ramifications of that and it’s not relegated to just the UK.
When the GBP/USD started to collapse last week this raised the possibility of even greater inflation in the future, because a weaker domestic currency means imported products are by default more expensive. It’s yet another major factor working against recovery of the UK economy.
This week saw GBP/USD actually go into collapse and set an all-time-low in the US Dollar, making the sell-off on Friday look rather light by comparison. But, similarly this raised the prospect of even stronger inflation even more – which will need even more rate hikes to tame – which puts even more pressure on the bond market and market participants holding a lot of bonds (like pensions). This also drives additional motive to sell more bonds – which means even higher yields.
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This explains the UK gilt market coming into this morning. And there was rumor starting to spread that there may be some major market participants in significant amounts of pain – which may lead to forced selling which could have damaging repercussions elsewhere.
This morning the Bank of England decided to step-in on the matter, in effort of quelling the fast surge in British bond yields. This is a very counter-intuitive strategy, because to do so the BoE will likely need to print GBP in order to buy bonds in the open market, which is a similar operation as QE. Buying bonds in the open market could help to hold yields down, but it also means that there will be more supply of GBP as the central bank prints cash to buy bonds.
That means more inflationary pressure, all factors held equal, as more supply of GBP could lead to a weaker spot price. Oh, and this is happening as the central bank tries to hike rates in the effort of stemming that inflation so it does seem as though the Bank of England is now in a position where they have to deal from both sides – raising rates while also printing currency.
To say that this is untenable probably seems obvious, but it’s an emergency action designed to cap a growing problem. Unfortunately, it’s hard to imagine that this is going to be the knock-out punch to that problem as it introduces other problems. And not to mention, the UK isn’t the only economy in a similar spot faced with extreme inflation and an economy that seems unable to bear the tighter monetary policy that will be needed to get that under control.
It’s a bad situation and while it’s showing in the UK today, it could be in Europe or the United States or, in a slightly different way in Japan at some point in the not-too-distant future.
This seems to the point of vulnerability at the moment and the big question is whether there’s another wave of selling to be had that may actually take the pair down to the parity psychological level.
The reaction to this morning’s news was extremely bearish, with GBP/USD dropping by 300 pips after the QE announcement. But – price did hold above a major support area around the 1.0500/1.0520 area, the latter of which was the prior all-time-low in the GBP/USD pair. Prices tested below that area very briefly earlier this week but there wasn’t a significant amount of time spent below. This is support until it’s taken out and if sellers take that out, that could be read as a very bearish indication.
There has been a bit of recovery since this morning’ spill and price action is working back into the prior range that build after the collapse-like move. Resistance remains around 1.0828 and there’s a mid-line for the range around 1.0737.
GBP/USD 30-Minute Chart
GBP/USD Bigger Picture
Taking a step back and we can put this recent volatility into some scope. Price action has naturally been pretty messy down here but, again, the big takeaway for me is that there hasn’t yet been a greater recovery and now the BoE has brought QE back into the matter.
A breach of the 1.0500/1.0520 area opens a door for a test of a swing-low at 1.0445 after which the new all-time-low at 1.0350 comes into play.
Below that is fresh snow that has never been touched, so I’ll usually default to psychological levels for support/resistance reads. The parity level of course sticks out but that becomes a problem unto itself if that level is in the picture, as there was a similar scenario in EUR/USD in March of 2015.
On the positive scenario – and I would anticipate that this would require some help from an economy outside of the UK, but a breach of that resistance at 1.0828 opens the door for a move up to 1.0931, after which the 1.1000 psychological comes into play. That would be a big deal in my mind, as there’s likely still a massive short position in the matter and pullback to 1.1000 would indicate some greater element of recovery.
GBP/USD Four-Hour Chart
Chart prepared by James Stanley; GBPUSD on Tradingview
GBP/JPY: Force x Mass
In GBP/JPY, there’s still some carry potential. The Bank of Japan hasn’t touched their rate policy at all even with their own intervention efforts and this, combined with higher rates in the UK, encourages the long side of the pair.
And this is why GBP/JPY has been sitting near six-year-highs for the better part of the past five months. The recent collapse in GBP has led to a strong pullback in the pair, with prices hurrying down to a major level of prior support-turned-resistance-turned-support again at around 149.00.
GBP/JPY Weekly Chart
GBP/JPY Can Cut Both Ways
If we are seeing some element of pivot around the Bank of Japan, the reversal could be massive as this pair was riding the trend of the carry for some time. The longer-term chart does show a bit of threat, particularly if we can see price trade through the above support at 149 and, bigger picture, below the 61.8% retracement of ‘Abe nomics’ move in the pair, running from 2011 lows up to the 2015 highs.
The 38.2% retracement has helped to hold the highs so far and a breach below the 61.8% retracement would make for a bearish longer-term picture. Shorter-term, however, if we can see some recovery take-hold in the Pound and I would be tracking a push above 156.37 and as initial sign of such, then the positive carry in the pair may allow for continued bullish behavior – but that would need a few things to line-up first; namely recovery themes in GBP and a lack of intervention threats from Japan.
GBP/JPY Monthly Price Chart
Chart prepared by James Stanley; GBPJPY on Tradingview
So, today we’re talking about the UK in a difficult economic spot. But, tomorrow may be Europe. EUR/GBP, on a longer-term basis, remains in-range even with the threat to breakout earlier this week.
On the back of this recent GBP-theme we’ve seen EUR/GBP move up to a resistance level that’s led to a number of reversals over the past 13 years. This is the 78.6% Fibonacci retracement of the 2008-2015 major move.
There’s a number of additional levels from that retracement that have been of use, with the 50% mark helping to hold support for much of the past five years and the 61.8% marker, plotted at .8709 functioning as a mid-line.
The current 13-year high is around the 88.6% retracement of the same move. If GBP continues in melt-down mode, that’s a level of interest for topside breakouts. And a push up to the .9805 level, which was the swing-high from 2008, would lead to a fresh all-time-high on the pair.
EUR/GBP Monthly Price Chart
— Written by James Stanley, Senior Strategist, DailyFX.com & Head of DailyFX Education
Contact and follow James on Twitter: @JStanleyFX