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Pound-Dollar Week Ahead: At Risk of Crumbling in a Volatile Week as Virus Threat Back in Focus

- GBP/USD seen under pressure in volatile and event-filled week. 
- Brexit meetings, fresh U.S., China virus fears, BoE policy in focus.
- GBP seen slipping back to 1.24, with risk appetite in driving seat.

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The Pound-to-Dollar rate shed almost one percent in what was a rollercoaster ride last week but is at risk of crumbling further in the coming days amid multiple technical and fundamental headwinds that could also see volatility increase. 

Sterling had gotten off to a fine start last week as risk appetite remained robust and the market mood jovial, which lifted the Pound-to-Dollar rate above its 200-day moving average at 1.2688 before prompting a clash with the 78.6% Fibonacci retracement of the March collapse at 1.2822.  

But the Pound was turned away from those levels Wednesday before sliding into the weekend as risk appetite waned in the wake of the June Federal Reserve (Fed) policy announcement and amid renewed fears in the market about a possible second wave of coronavirus infections in the U.S.

Sterling limped into the weekend Friday but could fall further yet as the signals coming off the charts remain bearish, while the currency confronts a cocktail of risks spanning Brexit, economic data and Bank of England (BoE) policy that could as a minimum, prompt a pickup in volatility over the coming days. 

The Pound will confront those risks as the supposedly non-essential retailers reopen in the UK for the first time since March. Meanwhile, the Dollar will also trade according to the broader market mood but with a negative correlation to the stock markets that turned lower in the latter half of last week. 

"The narrative has shifted – with an increased focus on second wave virus risks and the shape of growth going forward," says Daniel Been, head of FX research at ANZ. "With a number of our tactical indicators stretched at present, we think technical retracement in risk markets is a real possibility, while near-term consolidation of the recent risk rally should be expected at the very least. "

Above: Numbers of new coronavirus infections declared globally each day. Source: St Johns Hopkins University.

Both currencies are sensitive to stock markets that will respond early in the new week to the prospect of a second wave of coronavirus infections in the U.S. as well as China after parts of Beijing re-entered 'lockdown' at the weekend. New cases have continued to rise in a handful of U.S. states including Florida, Alabama, Louisiana and South Carolina while the global tally has increased with the ongoing outbreak in large but developing countries. 

That underlines the still-live virus threat to the global economy and financial markets, some of which had completely erased their coronavirus-related losses until last week's sell-off. Sterling tends to have a positive correlation with stock markets while the greenback is most often negatively correlated so the Pound-to-Dollar rate would likely continue tracking any moves lower.

This is after Sterling reclaimed its 200-day moving average at 1.2688 early last week only to slip back below it in Thursday trade before closing Friday evening near to the 1.25 handle, Further weakness would put Sterling into contact with the 21 and 55-day moving averages at 1.2440 and 1.2410, as well as the 38.2% Fibonacci retracement of the March rebound at 1.2283.

"After 10 consecutive daily gains for the pound (our rule of thumb is that 10-12 days’ worth of one-way movement is about all markets can typically sustain), some sort of dip in the GBP was becoming inevitable. Cable has edged back under 1.2650 and short term, bull trend channel support has caved in, tilting near term risks to the downside," says Juan Manuel Herrera, a strategist at Scotiabank. "A clear push under the low 1.26 area would point to more corrective losses towards the 1.2450/1.2550 range." 

Above: Pound-to-Dollar rate with S&P 500 stock index (orange line), moving averages & Fibonacci retracements.

"Caution is warranted. Dips lower should find initial support at 1.2468/86 ahead of the short term uptrend at 1.2379 which is expected to hold the downside. A daily chart close above the 78.6% Fibonacci retracement at 1.2818 is needed to target the 200 week ma at 1.2924," says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank

It's not just technical analysts who're bearish in their outlook for the Pound as there's also a growing line of others who also see the British currency remaining under pressure in the weeks ahead, with many citing the trajectory of Brexit talks, BoE monetary policy and coronavirus-related economic damage that's heavier than in most other developed countries. The rub for the Pound though is that all of those factors will be in focus among investors again this week. 

"Deadlocked Brexit negotiations, rising no-trade deal fears and the possibility of negative interest rates all point towards further sterling downside. This is especially the case if risk aversion gains momentum," says George Vessey at Western Union Business Solutions. "The pound remains on average around 10% lower against most of its major currency rivals since the UK voted to leave the EU in 2016, and a no-deal scenario would likely send it another 5-10%."

Prime Minister Boris Johnson will e-meet EU chief executive Ursula Von der Leyen Monday, ahead of Thursday's European Council summit, and many in the analyst community are hoping to see a push for compromise between the two parties, although few have much confidence that one will come. 

Above: Dollar Index at daily intervals S&P 500 stock index (orange line).

Many investors are already betting against Sterling and the market has become well accustomed to the idea of deadlock in the trade talks so even a few words of optimistic ambition from the two leaders might be enough to seem like a game-changer on Monday. But if the meeting comes and goes while leaving only deadlock behind in its wake the Pound might struggle. 

"We expect a more volatile GBP in the week ahead. Beyond broader developments in risk sentiment, the outcome from the latest Brexit talks and BoE policy meeting are likely to be important for GBP performance," says Lee Hardman, a currency analyst at MUFG. "The sharp US equity market sell-off this week has been the first major setback for recovery trades...we believe that the upside for recovery trades is likely to prove more limited after strong gains in recent months. That may imply a period of consolidation for USD."

With Brexit talks to one side the highlight of the week for the Pound is Thursday's Bank of England policy decision which is widely expected to produce another dose of quantitative easing for the economy and HM Treasury, with the market looking for an additional £100bn of bond purchases to take the total amount acquired by the bank to £745bn. However, it's possible the Bank could announce more than that in its 12:00 policy decision.

The BoE has been buying close to £14bn of government debt per week since the coronavirus came along, which is close to £60bn per month and equal to around 2.6% of GDP. The UK government borrowed even more than that during the month of April, with the total having come in at £62.1 after HM Treasury took unprecedented action to limit the longer-term damage done to the economy by the 'lockdown' used to contain the coronavirus. 

"We assume a majority support £100bn increase at this meeting," says Robert Wood, an economist at BofA Global Research. "We expect the BoE to cut the QE purchase pace from the current £13.5bn a week. The intense market pressure that led the BoE to buy at the current furious rate has faded. But no MPC member has suggested cutting the purchase pace in public comments. So we have low conviction. Regardless of quantities and pace the BoE's likely message should remain pretty simple"we want to keep gilt yields from rising."

 

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