GBP/USD remains bearish for 1.1500?
By: Ron WILLAIM, CMT, MSTA – SAMT Vice President – Geneva Chapter
The pound is enjoying a welcome relief-rally from oversold extremes. It follows the historic post-Brexit -15% cliff-drop, which pushed into the lowest levels since 1985. Since then, sentiment has mildly improved as the announcement of a new British prime minister removes a layer of political uncertainty. Furthermore, this week’s expected rate cut from the Bank of England is also likely to offer additional respite.
Key upside technical levels to watch ahead of these events will be 1.3535 (29th June high) and 1.4130 (Brexit sell-off pivot level), with overshoot risk into 1.4270 (66% retracement). However, our analysis suggests that upside price reactions will be limited and that any rebound should be used as a tactical selling opportunity.
Stay alert for a potential déjà vu of the two-way volatility trap which occurred before and after the EU referendum on 23rd June. Many traders bought on the rumour of a Bremain victory, pushing the rate up by +7%, only to have their long positions trapped and reversed by a surprise Brexit result. A similar behavioural pattern of “buy on the rumour and sell on the fact” is likely to repeat once again and lead to new price lows.
Figure 1: Sell into the GBP/USD rebound from oversold extremes.
Source: The ECU Group, Multi-Asset Research & Advisory Team, Datastream, Market Analyst.
Technically speaking, the pound collapse should not have come as a big surprise. GBP/USD was already in a two-year bear trend, signalling a potential break under 30-year support at 1.4000. The move coincided with long-term 8-year market cycle which had successfully predicted every major bottom in last 40 years. The evolution of this technical price-time setup had triggered asymmetric risk and negative social mood ahead of the Brexit vote. Put simply, Brexit was not the cause, but actually the effect of already established negative sentiment from the ongoing bear market.
Figure 2: Technical picture signalled asymmetric risk ahead of Brexit
Source: The ECU Group, Multi-Asset Research & Advisory Team, Datastream, Market Analyst.
A study of major GBP/USD price slumps over the last 30 years gives an average drop of -21% (Figure 3). We have only achieved three quarters of this minimum price objective and therefore still have further downside to go. Meanwhile, the average time duration has been just over one year (15 months). This includes both the actual price decline and basing pattern process.
Figure 3: GBP/USD historical average price slump is -21%
Source: The ECU Group, Multi-Asset Research & Advisory Team.
Using this historical average as a basic yardstick tells us there is still have another 5% to go into 1.1500. This is a minimum price objective and price action could deviate in around this level. It is also important to take into consideration that market bottoms take time to evolve after a major price shock. Markets don’t move in a straight-line and will likely give false upside signals, underlined by a further retest of the lows, before developing a true price low/bottom. Timing cycles signal probable window into Q4 2016/early 2017.
It is interesting to note the growing change in sentiment toward having a cheaper GBP. The pendulum seems to have reversed from the old polarized expectations of the economic impact of a Brexit outcome. Here and now, mainstream and government rhetoric is now voicing potential benefits of competitive pricing for UK exporters, cheaper assets for international investors and reduction in current account deficit (BOE est. by one third). This sharp change in sentiment highlights a potential realignment with the new price equilibrium and will help signal a price bottom into Q4 2016/early 2017.
Figure 4: GBP/USD remains bearish for 1.1500
Source: The ECU Group, Multi-Asset Research & Advisory Team.
Disclaimer: the above article is for general information and educational purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.