Automatic trading programmes may have been behind the outsized slump witnessed in Pound Sterling over the course of the past 24 hours.
- British Pound to Euro exchange rate today (21/9/16): 1.1652, three day best rate: 1.1717
- Euro to Pound Sterling exchange rate today (21/9/16): 0.8623, three day best rate: 0.8631
- Pound to Dollar exchange rate today (21/9/16): 1.2958, three day best rate: 1.3075
There was something strange about Sterling's notable slump on Tuesday the 20th September.
The declines - in some cases well over 1% - occured as foreign exchange markets were happy to trundle sideways with two big central bank meetings lying ahead.
The Pound was at one stage 0.6% lower against the US Dollar and Euro but 1.16% against the higher-yielding New Zealand Dollar and 1.4% against the South African Rand.
There were no major headlines to attribute the sudden lurch lower which has lead to one analyst pointing the finger at automated trading programmes.
"Sterling is broadly lower for no obvious reason. There have been no data reports today. UK gilts are out-performing, meaning UK yield have fallen relatively more than elsewhere, which may be dragging on the GBP’s performance," says Shaun Osborne at Scotiabank.
"GBP/USD slide below 1.30 was reportedly driven by algo selling which managed to trigger stops below the figure," says Osborne.
Selling in GBP/USD here will certainly have been felt right across the British Pound complex where similar action will have been experienced.
We also warned that it is important for those watching Sterling to stay calm and watch for a recovery into the close.
This did indeed happen against many pairs and while GBP/USD remains below 1.30 we note GBP/EUR is back above 1.16 and is virtually unchanged over the past 24 hours.The key support levels agianst the Euro have held as expected.
Nevertheless, there remains an elevated risk of further losses from here.
Scotiabank's Osborne says, "heavy selling last Friday was perhaps the canary in the technical coal mine for the pound, as it drove spot below the 40-day MA and clearly away from the recent peaks. A low close last Friday also formed the third leg of a longer-term bear reversal (“evening star”).
"Pressure leaves GBP/USD resting on major support at 1.2920/25, in our opinion; this is effectively the floor of the post June consolidation and the base of a broader bear wedge pattern; loss of support here would tip medium-tem risks decisively lower for the pound."
GBP has the Ability to Move Higher: Nordea Markets
We can already see where the potential shock factor of the week ahead lies - the interest rate and policy decisions due out of the US Fed and Bank of Japan on Wednesday.
No changes are expected at the Fed which should be the most important of the two.
Such a move should, theoretically, be positive for the Pound which would likely advance against the US Dollar.
Expect stocks to be sold, the Dollar to rise and the Pound to fall were the Fed to raise rates as this would be an unexpected move.
“In light of expectation that this global downturn in global sentiment is temporary, I still do think that the GBP, the riskiest among G4, should firm more. It is still possible that the BoE gets a positive surprise by November. And it strikes me too that we have seen some divergence with its key recent drivers," says Aurelija Augulyte at Nordea Markets.
Augulyte asks whether, “something's got to give?”
As can be seen above, while the traditional safe-haven assets of gold and US treasuries have fallen as markets turn more confident, the EUR/GBP exchange rate has not.
Therefore, we could be about to see further Pound strength against the Euro.
A potential trigger for such a move could be the FOMC meeting this Wednesdaywhich is likely to result in another delay on raising interest rates as recent US economic data has shown a slowdown in demand.
A delay will be positive for stocks while a cut would come as a shock and send stocks lower and the Dollar higher.
This would in all liklihood impact negatively on Pound Sterling.
"Even if the Fed does not tighten in September it may signal with a high degree of confidence that it is willing to raise rates by 25bp at the next full meeting in December. That could be enough to rally US yields even higher and provide a basis for a more sustained dollar rally," says Boris Schlossberg at BK Asset Management.
Morgan Stanley Turning Cautious on Sterling
While post-Brexit UK economic data has held up better than expected, we hear analysts at Morgan Stanley have told clients they are turning more cautious on GBP.
We reported last week that Morgan Stanley saw a potential 3% upside in Sterling having noted the currency as being oversold in this post-referendum period. That they have shifted to a more negative tone will come as a worry to those hoping for a stronger GBP.
"In the latest minutes, the BoE reiterated that it will continue to ease if inflation and growth come in line with their August forecasts. However, markets are only pricing in a 7bp rate cut for this year, giving room for GBP to weaken if data starts surprising to the downside and BoE rate expectations are repriced," say Morgan Stanley.
In addition, even though recent economic data has held up well, analysts still expect Brexit to drive a growth slowdown which will play out over a longer time horizon.
Morgan Stanley observe the government's negotiation position regarding Brexit also remains unclear, with risks titled towards a hard exit that significantly reduces the UK's access to the EU market.
British Pound Lower on Bank of England Rate Cut Expectations, Evolving Brexit Story
One of the reasons the British Pound has been under pressure over recent days has been the evolving Brexit story.
GBP was the second-biggest loser in the G10 last week due largely to a report on Friday (according to Bloomberg) that the UK is willing to give up on EU single market access in its Brexit negotiations.
“With the government staking its credibility on regaining control over U.K. borders after the June 23 Brexit vote, Hammond considers it unrealistic to expect actual membership of the single market after Britain leaves the EU, the officials said, speaking on condition of anonymity because the discussions were private,” notes the Bloomberg report.
If this story evolves over the course of the coming five days we would expect Sterling to trade with a heavy tone, so keep an eye on the newswires.
The other issue weighing on Sterling sentiment is the Bank of England.
Despite no change being delivered at the September policy meeting markets continue to anticipate another interest rate cut in November.
"Looking forward, we maintain our call of a November rate cut on the back of recession in H2 16. Indeed, if we are right in our forecast, then the November MPC will face a materially worse macro outlook than it currently expects,” say Barclays in a note to clients.
"Faced with a GDP slowdown, we would expect MPC members to support a rate cut in line with the message so far. This call is however subject to some risks. In particular, data may continue to challenge our forecasts.”
Pound Forecast to Fall Back Below 1.30 Against US Dollar
On the back of expectations for another interest rate cut we hear many strategists remaining negative on the Pound going forward.
“Our economics team no longer expect a further increase in QE this year but they continue to forecast a 15bp rate cut at the November meeting, which is considerably more than current market pricing,” say BNP Paribas in a note to clients. “We remain broadly bearish on the GBP accordingly targeting a break below 1.30 in GBP/USD over the coming weeks.”
BNP Paribas’ STEER model signals GBP as being expensive, currently hold a short GBPUSD and long EUR/GBP trades.
Contrast this to the views held by SEB where analyst Karl Hammer says the Pound is actually too cheap at current levels.
So with the GBP/USD destined for below 1.30 in the eyes of some, what of the GBP/EUR?
We have noted here that the current pattern in this exchange rate suggests weakness could well extend to 1.1450 but at such levels the currency pair looks too expensive.
We believe this currency pair has become a rangebound play, so we would expect any weakness to become increasingly limited in the approach to 1.1450-1.15.
Likewise, strength is likely to fail at the recent highs at 1.20.
We don’t expect much excitement from this pair this week.