British Pound to Dollar Rate Forecast to Fall Back to 1.35 by Societe Generale, Others See Momentum Fading

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The pound sterling may have hit its maximum and is predicted to be on the path back towards 1.35 by analysts at Societe Generale.

  • Thrust behind lower GBP/USD forecasts is an expected strengthening in the US dollar.
  • "While a move below 1.4400 would not be surprising, downward momentum is not strong" - U.O.B.

Those looking to exchange pounds into dollars should be aware that the purple patch we have witnessed over recent weeks may ultimately be about to come to an end.

The pound’s rapid rise has caught many by surprise, particularly if we consider just the rapid decline in the pound as markets woke up to the risks associated with the upcoming EU referendum.

The recent fall in US real yields has triggered a bounce for index-linked gilts vs. TIIPs and that helps explain part of the bounce in GBP/USD of late.

Yield spreads and the pound to dollar

This has been aided by a realisation that the sell-off on the basis of an UK exit from Europe was potentially overestimated. Markets had to buy GBP to cover up for the fact that there remains a mere 33% chance of this happening.

The rally does however appear to have reached a limit, something we at Pound Sterling Live were growing increasingly wary of towards the end of April.

The question, as always, is where next?

Stepping forward with their forecasts for the UK unit are Societe Generale who warn we are about to see deep declines ahead.

In fact, analyst Kit Juckes warns that the pound to dollar conversion is likely to break below 1.40 in convincing fashion.

“For now, we’re shaking positions out but the dollar’s low will be seen in Q2, whatever happens in reaction to this week’s data. We’ve one toe in the water with short NZD/USD and now another with short GBP/USD,” says Juckes.

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As can be noted, the thrust behind the lower GBP/USD is likely to emanate from a strengthening US dollar.

Juckes argues that what those betting on a further decline in the US dollar needs is a combination falling/low real yields, and falling/low volatility.

“From current levels (high equity multiples, very low real yields, very low volatility) it’s going to be hard enough to maintain such friendly conditions for a dollar bear, let alone improve them further,” says Juckes.

This is really a way of saying that once the position unwind is over, the bears will be flushed out by either increased asset market volatility or by renewed expectations of Fed tightening (and higher real yields).

Rationale for a Lower British Pound

While the dollar is forecast to recover, Juckes and his team at Soc Gen are also unconvinced on the UK economy’s ability to command higher levels in GBP.

The UK economy is slowing steadily. This week we had confirmation that the three main pillars of the economy - services, construction and manufacturing - are all slowing down at a faster-than-expected rate.

It is note that real GDP growth has slowed from a 3% annualised growth rate in the second half of 2013 to 2% in the second half of last year and on current trends, something closer to 1% in the first half of 2016.

In terms of market positioning Juckes argues that there is still enough space left in the market for further entrants into the short GBP-USD play.

Juckes argues that the rally in gilts, a large reason for sterling’s own rally, is unlikely to be sustained, something corroborated by the team at TD Securities. (Note here that TD are also forecasting a decline in GBP/USD to 1.35).

“Higher real yields in the US would be very bearish for GBP/USD, while falling UK real yields in isolation would be pretty negative too,” says Juckes.

In short, “there’s enough to justify a short in GBP/USD. Our stop is 1.48, our target 1.35,” says Juckes.

Such a decline, if it does come to pass, will represent a massive shock for those looking to exchange pounds into dollars. In fact we would expect the flow by the retail market to pretty much dry up.

The decision to forgo sizeable international payments would be justified in view of the fact that these levels were last seen in the 1980's and many would expect such low levels to be a permanent feature.

Therefore those with currency payment needs should talk to their broker about having a stop-loss placed around the 1.40 marker.

Downside Momentum in GBP/USD Fading

Another way of approaching GBP/USD is from a technical perspective - price action as depicted on the charts has the ability to provide insights as to future action as it betrays an underlying structure to the market.

With that in mind we have noted a number of arguments that suggest the pound's weakness is likely to remain limited going forward. 

"We turned neutral GBP last Wednesday and were of the view that the corrective pull-back from the high 1.4770 has scope to extend lower to 1.4400. While a move below 1.4400 would not be surprising, downward momentum is not strong at this stage and a sustained move below this level appears unlikely," says Quek Ser Leang at United Oriental Bank in Singapore.

That said, a clear break below 1.4400 (say a daily closing below) could lead a quick drop towards the next support at 1.4300.

"Overall, GBP is expected to be on the defensive unless it can reclaim 1.4545 in the next few days," says Leang.

Strategists at Credit Suisse are watching support at the 38.2% retracement of the February/May recovery at 1.4414.

"We allow for a bounce here, but beneath here we can then look to the 55-day average and the top of the former base at 1.4377/48," say Credit Suisse.

Capitulation below price/50% retracement level at 1.4303/4299 is required to signal a more sustained sell-off to 1.4090, ahead of the early April low at 1.4006.

Resistance moves to 1.4573/80, then 1.4641, with Credit Suisse arguing that a break above 1.4771 is needed to turn the trend higher again to test a bigger obstacle at 1.4847/83 – the 50% retracement level and the falling 200-day average.

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