Idea of the Day a Sterling Idea

What: GBP/USD has fallen below 1.30 on the back of weak manufacturing PMI data released this morning. The market was disappointed with the 54.3 reading for June, which was the lowest level for three months, it had been looking for 56.3. This knee jerk reaction lower in the pound has been driven by economic concerns about the failure of the UK manufacturing sector to benefit from the weakness in the pound. However, we think that this is an overreaction to the manufacturing data and that short-term weakness in sterling is an opportunity, as we expect the UK currency to break key resistance at 1.3050 before long.

How: There are a few reasons for our view. Firstly, investors are warming to sterling. Bloomberg’s fear/greed indicator for GBP/USD remains in positive territory, as you can see in the chart below. This means that there are more GBP bulls than bears at the moment, based on GBP/USD’s average true range. This suggests that right now the bulls are in control. Even though sterling has fallen on Monday, the divergence with the F/G indicator suggests that this pair could stage a recovery. Secondly, we believe that the prospect of a rate hike is not fully priced in by the market. The probability of a rat5e hike by the end of this year has risen to more than 50%, which is the highest expectations for more than a year. The prospect of a rate hike from the UK hasn’t driven sterling substantially higher, but we expect this to come. Lastly, we think that the market is overreacting to the manufacturing sector PMI’s, the important data point is the service sector survey, which is released on Wednesday, which is a better gauge of the UK economy. If this survey is stronger than expected then we could see a bounce back in the pound.

From a technical perspective, a move back to 1.2850 – the high from 28^th June before GBP/USD jumped on the back of hawkish Carney comments – is key support and if cable does dip towards this level, say 1.2860, then we could see some buying interest. If GBP/USD falls below here, then it could be a sign that GBP/USD downside has further to go, so our idea would be negated. On the upside, we would look for a move back to 1.3030 – the recent high - initially, if we see a strong services sector PMI then this may open the way to 1.3150.

Chart 1: 

Source: City Index and Bloomberg