After last week’s Brexit vote, the UK has been plunged into a political turmoil, fears over the domestic and European economies have intensified and investor sentiment severely damaged. David Cameron already made a swift decision to resign as Prime Minster, although he will remain in charge until the Conservative party elects a successor. The turmoil exacerbated over the weekend with several labour MPs resigning as the party’s leader, Jeremy Corbyn, faces a vote of no confidence following his role – or lack thereof – in the Bremain campaign. And the Scottish government is threatening once again to leave the UK as it wants to stay in the European Union. On top of all this, the EU is apply the pressure, insisting that the UK should trigger article 50 immediately to initiate formal talks on leaving the union.
Amidst all the uncertainty, the pound is getting crushed once again today and it has dropped to a new three-decade low against the dollar; stocks in the banking, building and travel sectors are tumbling, and the benchmark 10-year government bond yield has dropped to 1% for the first time ever. Consequently, shares in companies such as Barclays (LON:BARC) (-10.4%), RBS (LON:RBS) (-14.5%), EasyJet (LON:EZJ) (-19.4%) and Barratt Developments (LON:BDEV) (-12.1%) were briefly suspended this morning. However, the FTSE was not the worst performing index in Europe, as it found good support from rising share prices in gold miners and defensive stocks. Still, I don’t see how the market will avoid further falls without the intervention of the Bank of England or the European Central Bank.
As far as the pound is concerned, well it has dropped another 3.5% against the dollar today to a low so far of $1.3190, its worst level since 1985. It could fall further if the Bank of England moves to cut interest rates to zero or expand QE. So far, that’s what traders are speculating on. But they should not get ahead of themselves, because now the US central bank is also unlikely to raise rates this year, which should help to limit the dollar’s potential gains.
Technical outlook
At the time of this writing, the cable was testing Friday’s Brexit low of 1.3225, now as resistance. Should it hold below this level then it could lead to further follow-up technical selling pressure. However, the RSI is clearly in a state of positive divergence on the 1-hour time frame, so the selling momentum may be weakening slightly. Indeed, it is around these extreme levels that the latecomers get in trouble some times. Traders should get a good feel for price action here.
If the GBP/USD holds below 1.3225 for a while then it may start to head lower once again. In this potential scenario, the next stop could be around 1.30: here, the 127.2% Fibonacci extension level of the rebound from Friday’s low converges with the psychologically-important level. The 161.8% of the same price swing comes in at 1.2760. This could be the second bearish target.
Conversely if the GBP/USD starts to move back above 1.3225 then we could see a rebound of some sort. This may either be a small or a big bounce. Astute traders will not take any chances, as price has already dropped significantly to say the least and trading has been heavily one-sided, which means the odds for a short-squeeze bounce are rising fast. In any case, the first potential level of resistance to watch in this scenario would be around 1.3350, previously support. There is also the weekend gap that hasn’t been ‘filled’ yet, between the 1.3515 to 1.3675 area. The key resistance area is around 1.40, but this is now some 800 pips away and we may not get there any time soon.
So, in short, the path of least resistance remains to the downside for the pound, but be wary of potential short-squeeze rallies every now and again. However, I think that every potential bounce will be faded until the political situation of the UK becomes clear, which could take several weeks.
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