hasan.ahmed2501
Long

GBP USD MAJOR LOWS WILL FACE A REVERSAL

FX:GBPUSD   British Pound/U.S. Dollar
All the hallmarks of a text book trade oversold major lows all of that you know what to do guys start buying right now and lets eat right.
isa74
2 months ago
We invite You to read our latest currency report. We discuss here the main factors that are now affecting the British pound: the Bank of England approach to Brexit with its pessimistic August projections, the strength of the current data from the economy. The pound is also influenced by information about the likely stance of both sides ahead of the Brexit negotiations. The raport ends with a look at the speculative positioning on GBP and our conclusions regarding its outlook.

The British economy is still able to beat expectations, despite BoE’s vision of damage to be done by Brexit. The uncertainty and worries stemming from the decision to leave the EU are still alive and prevent the pound from benefitting from the better data. Harm is also done by reports that Brexit negotiations are going to be tough, as both sides claim. In our view as the good data keep coming, BoE will be more open to changing its projections of Brexit consequences to the better in the November round. The Bank speakers can change the tone much earlier than this and may raise the bar for further easing. This should lead to a GBP rebound after September losses.

As a starting point let’s see how GBP looks from the TWI perspective – with its value measured against a basket of currencies of the main trading partners with weights depending on the structure of UK trade flows. At this angle GBP may be starting to be range-bound after the steep decline immediately after the vote. If what the TWI chart suggests is true then it is time for a rebound.

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The TWI chart suggests that after the massive post-referendum adjustment the pound has entered a consolidation phase.

Source: Macrobond, XTB

The pound lost much during September due to strong words from the EU on the difficulties the UK will face during Brexit negotiations (3,4% vs. EUR, 3% vs. USD, 2,6% in TWI terms). EU representatives warned that Great Britain is definitely not going to remain linked to the single market if it wants to deny access to its labor market to EU citizens and to tighten migration control. We treat this as a process of setting up the negotiation base before the formal part starts by the end of 1Q 2017. Most likely the negative effects of the decision to leave the EU will come out one day, but utilizing this idae to such an extent already now seems exaggerated.

BoE played its part in making GBP weaker. In August, when it announced its surprisingly large and wide new stimulus package it stressed the downbeat outlook for the real economy. From the statement released at that time we could read that the economy ‘weakened markedly’ and that ‘the UK is likely to see little growth in second half of the year’. The August projections showed much lower growth forecasts. This was the first time official numbers on Brexit consequences were released by BoE.

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The last, August projections made a strong case that Brexit will lead to severe slowdown (May projection values in parentheses)

Source: Bank of England

Additional information about the August projections found in BoE documents showed that the pace of consumption is to drop due to Brexit only in 2017. But investments are going to take a quick and strong hit. The benefits of GBP weakness are to be contained within 2016. Also, still this year negative trends on the labor market should start, with slightly weaker employment path and slightly weaker wage growth.

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According to the projection Brexit was to lead to quick decline in investments, consumption was to suffer only in 2017.

Source: Bank of England

BoE rhetoric has not changed much since that time, although it needs to be recorded that in the September statement the Committee admitted to ‘now expect less of a slowing in UK GDP growth in the second half of 2016’. However in the same document we read that ‘the contours of the economic outlook following the EU referendum had not changed’. When analysing the recent speeches by Carney, Cunliffe and Vlieghe we noticed the thought that the data was not as bas as expected, but the overall message was that if the economy follows the (pessimistic?) path of the projections then further easing is warranted, and if it deviates to the downside then the scale of further BoE action will be even larger. There was also an opinion by Shafik that further easing seems just a matter of time.

In August and early September the market valuation of further rate cuts was diminishing, but in the second half of September there were no changes in this respect. It suggests that due to BoE stance the market hesitates if it can move further in erasing easing expectations – despite the positive data flow.

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Implied probabilities that in November there will be: a rate cut (red line), no change (white), a rate hike (green).

Source: Bloomberg

BoE came close to announcing further easing, meanwhile the data do not want to ‘rot’ just yet. We assume that there will be a moment when BoE will have to admit in a clearer manner that it went too far in its dramatic post-Brexit vision. The October meeting would provide a great opportunity, if BoE did not switch from 12 to 8 meetings a year. 13-Oct meeting was the first one to drop out (the date was still present in the preliminary 2016 meeting calendar) due to the switch. BoE meets only on 3-Nov and this is also when the next (possibly better) projections are released. This seems a distant future, but we expect the pound to start changing direction much earlier and due to lesser premises, that BoE is going to change the projections and its tone.

What is left for us to do now is to listen to BoE speeches and track the UK data. We propose the following ‘road map’, which names the data releases that need to come out strong to make BoE drop the ominous rhetoric and push its growth projections higher. We think it is the right tactic in such circumstances to increase by a relatively small amount long GBP exposure after every of these readings (provided it can be called GBP-positive). The data grouped in frames come in one publication and its meaning for the pound should be analysed together.

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‘Road map’ for the pound – UK data that can lead to a change of BoE stance which in turn can lead to unlocking the GBP apreciation potential.

Source: Bloomberg, XTB

Let’s have a look on what good figures came out of Britain of late. It is worth noting that production rebounded instead of declining after the poor start of the year and that PMI index was very quick to recover from the Brexit shock.

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Business sentiment indicators show a wave of optimism after a brief shock caused by the referendum outcome, production holds on well.

Source: Macrobond, XTB

Already the August PMI report delivered a striking message: the monthly improvement was the strongest in the almost 25-year long history of the index. The employment sub-index moved up for the first time this year; there was a massive, one of the strongest ever improvement in output and new orders (both domestic and foreign). This was confirmed by actual data on foreign trade.

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Foreign trade picked up in recent months, adding more power to the passage of PMI reports about a surge in new orders from abroad.

Source: Macrobond, XTB

A similar thing happened to sentiment indices for other sectors: services and construction.

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The shock was gone equally quickly in other sectors: services and construction; the rebound caused the sentiment to return to pre-referendum levels.

Source: Macrobond, XTB

In September, PMI for the British industry went even higher despite market expectations for a correction after the August record-strong jump. As a result the indicator climbed in September not only the highest since the Brexit fears arose, but also the highest since June 2014. New export orders remained an important factor thanks to GBP weakness (the best improvement since the start of 2014, reports of improved demand from Asia, Europe, USA and certain emerging markets), but the report stressed that it was the domestic orders that were key this time. Thanks to this further rebound in the headline number, 3Q saw the most of business optimism of all the past quarters of this year. The increased demand caused the second increase in a row of the employment component which adds to the impression that entreprises treat the current improvement as sustainable.

It seems to us that the biggest positive surprise in real data was what happened to retail sales. It strengthened not only in August but also in July when there was a collapse of consumer and business sentiment.

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Retail sales have not shown yet any, even a one-off deterioration after the referendum.

Source: Macrobond, XTB

It is particularly important now for the entire economy, as the economic growth is based almost entirely on household consumption, accroding to 2Q data. It is also important in the growth structure that the revision to 2Q numbers last week increased the positive contribution from business investments in 2Q and showed it at a higher level than in 1Q (bear in mind that the collapse of investments is one of the strongest arguments of BoE when discussing the consequences of Brexit).

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GDP growth structure of the UK – recently almost entirely based on household consumption.

Source: Macrobond, XTB

Consumer sentiment described by GfK looks great, returning to the pre-referendum levels and even higher as in the case of ‘expectations about future economic situation’. The rebound started in August and was continued in September.

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Optimism of consumers was quickly restored, opinions about the UK economy’s future are even better than before Brexit vote.

Source: Macrobond, XTB

The return of optimism and the evaporation of Brexit fears can also be seen in the fact that future economic situation (in red) is again starting to be seen in a better light than the current situation (in green). When the referendum was approaching the difference dwindled to zero.

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The consumer assessment of future economic situation is again exceeding the same indicator for current economic situation; back in 2012-2014 this was quite natural, but as the Brexit issue gained publicity the difference went down to zero.

Source: Macrobond, XTB

Not everything is rosy. The recent industrial output rebound did surprise positively, but was received as negative news by the market. It occured that the positive surprise was caused solely by the volatile output of the mining industry (less important from the fx market point of view) while the manufacturing figure failed to reach the expected growth rate.

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Industrial output surprised positively, but only thanks to the mining sector; manufacturing recorded a weaker-than-expected growth.

Source: Macrobond, XTB

Let’s now move to the analysis of changes in speculative positions on GBP. The market has returned to the recent multi-year lows when it comes to net positioning. This means that there is appreciation potential in this currency when the reduction of historically very high GBP shorts starts. In the previous set of data from CFTC we had a sudden reconstruction of pound longs, but it can be seen now, that the market got rid of most of these. It looks like speculative investors are looking for the right moment to switch to long GBP play, but the additional circumstances, like the Brexit negotiations chatter makes it difficult to pinpoint it (there were several similar, failed attempts this year to switch market direction – seen as spikes in the GBP longs). Such an approach to GBP is in line with the results of our analysis.

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Net speculative positioning on GBP returned to historical lows which makes room for GBP appreciation; another quick correction after a spike in long positions shows that it is difficult to find the right moment when the market is ready to change direction.

Source: Bloomberg

EUR may still be burdened with fears about the condition of the Eurozone banking sector, which is why we decided to utilize this currency in the trade idea based on our view on GBP.



Conclusions: GBP was unable to benefit from better data recently. We assume that the dramatic vision of Brexit consequences by BoE in its August projection does not let the pound realize the upside potential. BoE wants to stay consistent and still communicates readiness to ease further, even if the economy follows the path of the GDP projection. The catch is that the projection was quite pessimistic – every analysis/guess on what Brexit will mean for the UK economy carries many risks and BoE most likely wanted to err on the side of caution. This is why we expect that a time is coming when BoE will adjust its tone to the streak of surprisingly strong data. This should allow the pound to start regaining what it lost since the start of September. The next meeting and projections is only on 3-Nov.

We think it is important to track if the main readings from the UK are strengthening the positive macro picture (as a necessary condition for the GDP projection to be moved higher, at least for the nearest quarters) – if this is the case then the pound may start to rebound sooner. If the Eurozone banking sector worries are still present in the next days and weeks then EUR will seem a good candidate to short against GBP.
+1 Reply
hasan.ahmed2501 isa74
2 months ago
thanks for all the information, much appreciated.
Reply
JovanVeskovic
2 months ago
i agreeeee !
+1 Reply
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