Join +750K new investors every month who copy stock picks from billionaire's portfoliosSign Up Free

Is GBP Being Unfairly Targeted?

Published 11/01/2017, 05:33
EUR/USD
-
GBP/USD
-
EUR/GBP
-
GB10YT=RR
-
DE10YT=RR
-

Monday was a bit like deja-vu for currency traders, and a keen reminder of how politics can play havoc with a currency. Sterling declined to its lowest level since October as political fears and the Brexit premium started to bite. The pound has managed to claw back some losses on Tuesday, but it remains at risk from a further decline in sentiment.

Why EUR/GBP is at risk

But, is the sell-off in the pound justified? Certainly the uptick in economic data at the end of last year makes it look like the UK economy performed surprisingly well in the second half of the year, even with all of the Brexit uncertainty. Even yield differentials suggest that the sell-off in the pound could be overdone, especially against the euro.

It’s all about yields…

The chart below shows the real yield differential between Germany and the UK (the 10-year sovereign bond yield – the core rate of inflation), and EUR/GBP. As you can see, as the yield differential has continued to decline as real UK bond yields are 1.06% higher than real German bond yields right now, yet EUR/GBP is still pushing higher. This is counter-intuitive, higher yields tend to feed through to a stronger currency, and vice versa. So, the pound is weakening vs. the euro even though UK yields are higher than European yields, all because of politics.

Don’t mess with politics

It is worth noting that politics has a powerful influence on FX markets, and Brexit uncertainty is likely to remain a key theme as we lead up to the triggering of Article 50 at some stage this quarter. However, politics have hit the pound in fits and starts – immediately after the referendum result last June, in October after the Tory Party conference, and at the start of this year. After these sharp sell-offs periods of relative calm and recovery tend to follow. Due to the pound’s favourable yield advantage over the euro, we think that EUR/GBP could be more at risk from a pound recovery, once the market forgets about the latest May comments and moves onto something else.

Why EUR/GBP is at risk

The technical perspective is also not great for EUR/GBP, which has given back some recent gains on Tuesday. It hit key resistance at 0.87247 – the 38.2% retracement of the EUR/GBP uptrend from June to October at 0.8724, which may limit how far the euro bulls are willing to push the single currency versus the pound. If we get some strong manufacturing data out of the UK on Wednesday then a move back to 0.8553 in EUR/GBP – the 50-day sma – is not impossible.

So, even though we still respect the Brexit premium, we think that politics could take a back seat for the pound over the next few days - or until the next negative headline in the press - which may give sterling time to recover. If this proves to be correct, then yield analysis suggests that EUR/GBP may correct first as it doesn’t have the yield advantage to underpin its recent move higher.

German-UK Real Yield Differential And EUR/GBP

Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient.

Any references to historical price movements or levels is informational based on our analysis and we do not represent or warrant that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, nor does the author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

Original post

Latest comments

Loading next article…
Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.