Will the pound’s santa rally continue?

December 1, 2016 3:31 pm by

So much for the pound’s rally having run its course in November, GBPUSD has taken another leap higher on Thursday. Technical traders may be getting excited by GBPUSD, which popped above the top of its daily Ichimoku cloud at 1.2643, it has cleared this hurdle this afternoon and GBPUSD is currently trading just below 1.27.

So, is this move justified?

This is a difficult question to answer. The UK-US 10-year yield spread is falling deeper into negative territory, as US yields rise at a faster pace than UK yields. Thus, GBPUSD does not have a yield advantage that is driving this pair higher. Instead, we think that the rally in the pound is down to the market reducing its stretched short position in GBPUSD, which could give this rally legs, potentially back to the 1.30 level. CFTC data, which measures speculative interest in the pound vs. the USD, has shown that short positions in GBPUSD have reduced for 6 out of the last 7 weeks, and it appears that this trend could continue. Due to this, we may see further upside for the pound in the coming weeks, due to the following factors:

  • Momentum: the reduction in GBP shorts is important to the future of the GBP rally. If we continue to see short positions getting scaled back, then the GBP may continue to rise on a broad basis. Momentum is particularly strong against the yen and its recent performance has been staggering, GBPJPY is up more than 14% since the start of November!
  • Political risks around Brexit are receding, as political risks elsewhere start to bite. The cost to insure UK sovereign debt has fallen sharply since spiking back in June.
  • Upside risks to growth after a positive Black Friday shopping season, and the potential for an increase in inflation in the coming months.

The technical indicators are also positive, we have already mentioned GBPUSD’s pop above the Ichimoku cloud earlier today, the next key resistance level for this pair is 1.2811 – the 100-day sma – and then 1.3055 – the 38.2% retracement of the June – October decline in GBPUSD, which is a major level of resistance.

However, we will keep an eye on the UK-US yield spread. If this continues to fall further into negative territory then GBPUSD may start to look fragile.

Figure 1: UK-US yield spread and GBPUSD

01_12_chart2

Source: City Index and Bloomberg

Overall, the pound has stolen the mantle from the dollar as the king of the G10 FX world, and there is every chance that this rally has some legs, we think that 1.30 is a potential for this pair in the coming days.

Figure 2: GBPUSD daily Ichimoku cloud chart

01_12_chart1

Source: City Index and Bloomberg

Will the pound’s santa rally continue?
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