It’s time to buy the British pound against the US dollar, known in markets as Cable, or, alternatively, Stirling.
That’s the view of Richard Grace, chief currency strategist at the Commonwealth Bank, who in a note out today writes that the pound looks set to benefit from short covering and improved economic data in the period ahead.
As a starting point, here is a chart from Grace that looks at net speculative positioning in the British pound, overlaid against movements in the GBP/USD. As it demonstrates, net short positioning is now at multi-decade extremes, corresponding with a plunge in the GBP/USD that occurred following the UK Brexit referendum in late June.
Grace suggests that the huge increase in short positioning has been driven by speculation over what Brexit will mean for the UK economy once Article 50 of the European Union treaty has been triggered, rather than what is has actually delivered since the vote.
“The bearish sentiment in GBP/USD has most-recently been driven by the potential ramifications of Brexit on the UK economy,” says Grace. “However, the incoming UK economic data post the late-June Brexit referendum has consistently rolled-in better than expected.”
And he expects that trend to continue, suggesting it will lead to a “short-squeeze higher in GBP/USD” in the months ahead.
“The combination of improving incoming UK economic data, limited net capital outflows pre-the triggering of Article 50, limited near-term strength in the USD until we get a December Fed funds increase, and the unwinding of record short GBP positions is likely to generate a short-squeeze higher in GBP/USD,” he says.
“In our view, we will see GBP/USD lift to the 38.2% retracement level (1.3646), and then the 50% retracement level (1.3908) of the Brexit referendum high of 1.5018 and post-Brexit referendum low of 1.2798.
From the current level of 1.3315, that would imply upside for the GBP/USD of 4.4% should his call prove to be correct.
Here’s a daily chart of GBP/USD, including the Fibonacci levels communicated by Grace.
While he freely admits that triggering Article 50 of the EU treaty will likely lead to further pressure on the pound, Grace believes that it will not be triggered this calendar year, suggesting at the earliest it will occur in mid-2017.
“It appears April-May next year would be the earliest window, with the likelihood of a delay given the complexity of the trade deals that have to be re-negotiated,” he says. “We also believe there is a 20% chance that Article 50 is never triggered given the change in sentiment that has run through the UK populace and parliament.”
Should Article 50 be triggered before this time, he suggests that investors should immediately abandon the trade, something that most would agree goes without saying having seen the initial market reaction to the UK Brexit referendum.
Grace also suggests that participants should “assess and consider exiting the long GBP/USD position just prior to the December 15 FOMC meeting if our 1.3908 target has not been reached prior to this date”.
“This is to accommodate the likelihood of a firmer USD post the 15 December FOMC meeting,” he says.
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