Market Overview

How To Trade The Pound Going Forward

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How To Trade The Pound Going Forward

It was unsurprising that the UK’s decision to leave the European Union was followed by a 10 percent slide in the pound, as both political and economic uncertainties had shaken markets. In addition, the Bank of England’s dovish guidance for monetary policy moved the pound even lower.

Nevertheless, the pound has come off its lows (although it’s still trading close to the lower end of the range), as the U.K. received a new prime minister (Theresa May) last Wednesday.

The Bank of England’s surprising move to keep interest rates on hold last Thursday also supported the pound higher, with the GBP/USD currently trading at 1.3285, and the GBP/EUR trading at 1.1971. Although Bank of England Gov. Mark Carney did make it clear that markets could expect new stimulus measures at its next meeting on August 4.

With the pound starting to pull back a little, it raises the question of whether the pound has been oversold, and whether it is time to book short-term profits on short pound positions.

Technical Indicators

The chart below shows how the GBP/ USD RSI fell to 25.95 on July 4 before bouncing back. A reading below 30 signals heavily oversold conditions. While the RSI has risen back to 34.72, it still reflects a very weak trading level for the pound.

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The GBP/USD had also fallen notably below the lower band of the Bollinger Bands, as it traded more than two standard deviations away from its 20-day moving average (red line). So, in the short term, the pound had certainly been technically oversold. While it has pulled back in recent days to trade within the Bollinger Bands, it is still very close to its lower band, suggesting that the pound could still bounce back further.

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In fact, the Stochastic Oscillator, as shown in the chart below, has already confirmed the short-term reversal in the GBP/USD.

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Given the temporary easing of political uncertainty and technical indicators signalling a potential short-term bounce back, this could be a good time to book profits on any short positions on the pound before it rises even further.

Upcoming ECB And Federal Reserve Meetings

Following the fresh new stimulus package from the Bank of Japan, other major central banks are also likely to hold a dovish stance. Both the ECB and the Fed's Janet Yellen, speaking on July 21 and 27 respectively, will want to avoid making their domestic currencies overvalued relative to the pound. Their guidance will likely pressure the euro and USD downward against the pound.

Long-Term Pound Outlook Still Bearish

Regardless of a potential short-term bounce back in the pound, the long-term outlook for the currency still remains bearish.

While May’s appointment has at least filled the UK’s leadership vacuum, the future of Britain’s relationship with the EU is still unclear. May was a pro-Brexit campaigner, so it is unclear whether she will be able to successfully re-negotiate favorable trade deals with EU’s leaders who are not pleased with the UK’s exit.

Lloyd’s Business Barometer, which reflects the level of business activity in the U.K., had been reported as falling from 32 to 6 in the first week of July. Lower business confidence is likely to translate into lower corporate investments and diminished consumer confidence. No matter how loose monetary policy conditions become, corporate executives will need to see more clarity in terms of its business relations with the EU and the full impact of Brexit on the U.K. economy, before engaging in large-scale investment commitments. This could keep pressure on the pound for a longer period of time.

Pound Trading Strategy

In terms of shorting the pound in the medium to longer term, it is strategically wiser to short the pound against the dollar as opposed to the euro. This is because the ECB is likely to be much more dovish than the Federal Reserve.

There is a good possibility the ECB could hint at aggressive stimulus moves such as expanding quantitative easing in its upcoming announcement — just in case. One thing is for sure: The EU had a beneficial economic relation with the U.K. The EU’s economic recovery had already been quite sluggish, and Brexit certainly is not going to help. As a result, the EU will have to be the most proactive in loosening its monetary policy conditions as required.

On the other side of the Atlantic, the Federal Reserve is currently caught in between being hawkish and dovish. On the one hand, recent economic data has been positive, with a strong employment report of 287,000 jobs created in June and the unemployment rate at 4.9 percent.

But on the other, the economic impacts of Brexit are still unclear. Given the unprecedented nature of this event and other central banks weakening their domestic currencies, the Fed will be reluctant to raise interest rates in order to keep the dollar internationally competitive. This delaying of interest rate hikes is certainly not as dovish when compared to EU’s potential aggressive stimulus measures; so, even though both currencies will face downward pressure, the dollar is expected to remain steadier than the euro.

Even though technical indicators suggest a potential bounce back in the pound, the Brexit aftermath is far from over. Traders may want to take advantage of any short-term upward movements in the GBP/USD, by taking new short positions.

Posted-In: News Eurozone Technicals Forex Events Global Markets Trading Ideas Best of Benzinga

 

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