GBP/USD downside may be tempered by falling US inflation expectations, which could weaken the dollar.
The daily chart of GBP/USD is looking quite bearish: the longer-term trend remains down, and there is probably an a-b-c move down from the 18 March highs which appears incomplete, with the potential for more downside as a ‘c’ leg evolves lower, as part of an a-b-c correction.
The more recent recovery bumped into tough resistance from the 50-day moving average (MA) above, which is a line where bullish prices often pause due to clustering sell orders.
The 50-day MA is a major moving average which many traders both private and institutional use to gauge the directional bias of the market.
Whilst the chart looks poised for another wave down, such a move might be curtailed by falling US inflation expectations.
Not only was recent inflation data out on Monday, below expectations, but also a technical analysis of the chart of the US 2-year, treasury yield, reveals bearish implications.
Treasury yields about to fall
Treasuries are US government bonds - much like UK Gilts; the two year is a particularly useful indicator of medium-term inflation expectations, and therefore a guide as to the trajectory of Fed policy.
If treasury yields go up then markets think inflation will - if down then the opposite.
The chart below shows the 2-year Treasury Bill yield (T-bill), which is looking decidedly bearish.
The market has been consolidating after the long move down at the March Fed meeting on the 16, when the Fed reduced their interest rate hike expectations from an average of four to only two in 2016.
The churn higher since after the meeting appears as merely a corrective move within a dominant down-current, a possible ‘b’ wave of an incomplete three-wave move lower, with wave ‘c’ still to unfold down.
Copy signals, Trade and Earn $ on Forex4you - https://www.share4you.com/en/?affid=0fd9105
This shows that there is compelling technical evidence of lower market expectations of inflation.
Lower inflation means the Federal Reserve is less likely to raise interest rates, as this is a tool for cooling down an economy where prices are rising.
Not raising interest rates is negative for the dollar, as it goes against current expectations that the economy is cranking up and the Fed will raise them.
Janet Yellen is due to give a speech on the Economic Outlook and Monetary Policy at the At the Economic Club of New York Luncheon, on Tuesday 29, and this could indicate that she may take a more cautious line than expected.
From a technical perspective, the T-bill chart is indicating a move down to 0.8000 is probable, particularly if there is a break below the 0.8500 for confirmation.
The yield is all the more likely to fall to 0.8000, as its significant is heightened because it is where the 50-day and 200-day MA’s are situated.
Moving averages often provide an obstacle to falling prices as traders tend to place pockets of buy orders there, which slow down the sell-offs.
The yield therefore will probably fall and stall at 0.8000.
What this means for GBP/USD is that the pair is unlikely to fall deeply in the short-term.
The strong S1 monthly pivot at 1.4137 would normally be expected to stop price falling any deeper, as traders tend to cluster their buy trades around it.
This level may become a base for a continued move sideways for GBP/USD, or maybe even a marginal appreciation.
Indeed, MACD, a momentum indicator is rising, showing underlying strength in the market.
GBP/USD already too low according to Unicredit research
The pound is already heavily undervalued according to a research note by Italian lender UniCredit
Unicredit argue that most GBP/USD’s weakness is due to investors selling the pound out of fear of a Brexit, and not the difference between interest rates in the US and the UK, which is the normal driver of value.
Using a forecasting model called‘uncovered interest rate parity condition’ which compares the expected interest rates of domestic assets with the expected interest of foreign assets - once converted into the same currency - they determine the ‘fair value’ according to interest rate differentials.
Unicredit normally use the model to forecast movements in the spot exchange GBPUSD rate, which tends to move towards the fair-value of the model, however, since mid-December a large gap has opened up between the two.
The gap has opened up as a result of a new influence in evaluating the pound side of the pair – the risk of a Brexit. According to their model this is now equivalent to a 7% depreciation of sterling against the dollar.
The ‘referendum premium’ as it is also known explains the gap between the actual GBPUSD exchange rate and UniCredit’s short-run forecasting model.
This explains why US treasury or UK gilt yields are not the only influence on GBP/USD.
It also suggests a hidden upside potential assuming the majority of the UK populace vote to remain in the EU.