Has The Pound Been Oversold?
Sankalp Soni | Jul 14, 2016 04:14PM ET
It was unsurprising that the UK’s decision to leave the European Union on 23rd June was followed by a 10% slide in the Pound, as both political and economic uncertainty 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 this week (though still trading close to the lower range bound), as the UK received a new Prime Minister on Wednesday. The appointment of Theresa May into power means that Britain’s political uncertainty has been eased to a certain extent. A process that was going to go on until September has instead been completed in a matter of weeks since the Brexit.
The Bank of England’s surprising move to keep interest rates on hold on Thursday also supported the Pound higher, with the GBP/USD currently trading at 1.3285, and the GBP/EUR trading at 1.1971. Though Mr. Carney did make clear that markets could expect new stimulus measures at its next meeting on 4th August.
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 touch 25.95 on 4th July, before bouncing back. A reading below 30 signals heavily oversold conditions. Whilst the RSI has risen back to 34.72, it still reflects a very weak trading level for the Pound.
The GBP/USD had also fallen notably below the lower band of the Bollinger Bands®, as it traded more than 2 standard deviations away from its 20- day moving average (red line). Hence in the short- term the Pound had certainly been technically oversold. Whilst 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.
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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Nevertheless, given the temporary easing of political uncertainty and technical indicators signalling a potential short- term bounce back, this would 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
Moreover, following the fresh new stimulus package from the Bank of Japan, other major Central Banks are also likely to hold a dovish stance. An announcement from the ECB is scheduled for 21st July, and Fed Chair Janet Yellen will be speaking on 27th July. Both will want to avoid their domestic currencies becoming overvalued relative to its trading partners’, namely the UK’s Pound. Their guidance will likely pressure the Euro and USD downwards against the Pound. Hence once again, it would be wise to book profits on ‘Short Pound’ bets at this time.
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.
Whilst the UK’s political leadership uncertainty has vanished as Theresa May takes over, the future of Britain’s relationship with the EU is still unclear. May was a Pro- Brexit campaigner, hence it is unsure whether she will be able to successfully re- negotiate favourable trade deals with EU’s leaders, who have not been pleased with UK’s exit.
Lloyd’s Business Barometer, which reflects the level of business activity in the UK, had been reported to fall 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. Hence, 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 UK economy, before engaging in large- scale investment commitments. Therefore, the pressure on the Pound could certainly remain for a long period of time.
Pound Trading Strategy
In terms of shorting the Pound on the medium to longer term, it is strategically wiser to short the Pound against the US Dollar as opposed to the Euro. This is because the ECB will be much more dovish than the Federal Reserve.
Brexit will undoubtedly have much greater economic consequences on Europe than it will on the US. In its announcement on 21st July, there is a good possibility the ECB may potentially hint at aggressive stimulus moves in case it is required, such as further expanding QE. One thing is for sure; the EU had a beneficial economic relation with the UK, even running a trade surplus with the nation. Hence the loss of the UK will inevitably hit the EU economy harder than any other economy in the world. Given the fact that its economic recovery was already quite sluggish, Brexit certainly does not 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 being created in June, and the unemployment rate at 4.9%. And on the other hand, 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 USD internationally competitive. However, the delaying of interest rate hikes is certainly not as dovish in comparison to EU’s potential aggressive stimulus measures. Therefore, whilst both currencies will face downward pressure, the USD is expected to remain steadier than the Euro.
Hence, it may be more profitable for traders to short the Pound against the USD than the Euro.
In conclusion, whilst technical indicators suggest a potential bounce back in the Pound, the Brexit aftermath is far from over. Traders should take advantage of any short- term upward movements in the GBP/USD, to take new short positions.
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