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C&C market review, long GBP/USD?


By Darshan Viswanath, Jeet Shah, Ryan Teo Zhi Kai, Gopal Modi, Maria Dupré, Max Trapnell, Oliver Armitage, Anshuman Bhatnagar from the C&C team at LSESU Trading Society


GBP/USD

This week’s vote-counting favouring Joe Biden has resulted in expectations of a larger stimulus package and freer trade, leading to an expected depreciation of the US dollar against other currencies, including the British pound. However, the density of events in the past week has caused the FX market to be a roller coaster.

The announcement of a national lockdown in the UK caused the GBP to fall against the USD on November 2nd, reaching its lowest level in almost a month, but analysts are confident that hopes for a Brexit deal could prevent the GBP value to drop any further. After this sudden change of direction, the GBP value went up again by 0.6% on November 3rd, trading at its highest level in a week, $1.3075. On November 4th, investors were still waiting for the result of the elections and the control of the Senate by the Democrats seemed unlikely, resulting in a downward revision of expectations of the size of the stimulus package. Therefore, the FX market experienced volatility, with the GBP weakening again against the dollar, losing almost 1% of its value and reaching a level of $1.2990.

Following the Bank of England’s announcement of the increase in the size of the already enormous bond-buying stimulus package on November 5th, the GBP strengthened against the USD. Additionally, investors expected losses for the USD as the vote counting showed that a divided government, with Democratic presidency and Republican Senate, is likely. By the end of the week, as Joe Biden took the lead in key states and put himself on track for winning the elections, currencies considered riskier than the USD, have strengthened. Specifically, the GBP went up by 1%, trading at around $1.31 on November 6th.


Source: Trading 212


AUD/JPY

AUD/JPY has experienced a volatile week with a number of factors likely impacting its price movement. On November 1st, AUD/JPY slipped to just above its monthly low of 73.10 in anticipation of the Royal Bank of Australia slashing interest rates from 0.25% to essentially 0 on November 3rd. Investors’ low appetite for risk kept the safe haven Yen strong contributing to a lower AUD/JPY. Yet, despite the dovish RBA announcement, the following days saw a 3.1% rise in the AUD/JPY with a high of 75.45 on November 5th. The progress of the US election can explain this dramatic move:

Market sentiment has shifted towards favouring a Democrat president with investors seeming to now prefer stability and a large fiscal stimulus over a low tax environment. Thus, as the election progressed and a blue victory became more likely, investors moved from risk-off to risk-on and AUD/JPY, a currency pair known for its strong positive correlation to risk-on environments, climbed as a result. Meanwhile RBA’s interest rate slash was accompanied by an announcement from Governor Philip Lowe that demonstrated optimism for short term economic recovery in Australia, suppressing the market impact of a much-anticipated event.

Over the last couple days, November 5th to 7th, the AUD/JPY has found resistance, being unable to break 75.5. In the medium to long term, the AUD/JPY will mainly be determined by investors risk appetite. Lockdowns across Europe continue, the results of the US election will be contested and the Democrats will unlikely take the Senate. These are still dominant factors in the market that may see safe havens like the Yen favoured, pushing AUD/JPY downwards.


Source: Trading 212


Commodities

Gold

As President Trump continues to question the validity of the recent US presidential election results, investors remain focused on fleeing to safe-haven assets with gold futures seeing their best weekly gains since July, before stabilising around $1,950 for the first time since late September. Rising gold prices also reflect the market’s increasing acceptance that Biden will enter the White House this coming January.

Biden’s Democrats have made delivering another Covid-19 stimulus programme - similar to March’s $2.2tr CARES Act – their priority. While the Democrats look unlikely to wrestle control over the Senate - the passing of an eventual substantial fiscal stimulus looks increasingly likely as Biden edges towards presidential victory and US Covid-19 cases continue to rise. The prospect of an imminent fiscal stimulus, combined with the likely loosening of US monetary policy, has strengthened gold prices given the inflationary effects of such policies on the USD and as investors seek alternative safe-haven assets.

However, the possibility of a slowdown of business and consumption activity in the US may bring about deflationary pressure upon the USD which, in turn, may drag gold prices down as USD rises. With Covid-19 cases continuing to rise in the US, the likelihood of European-style lockdowns (and thus economic disruption) is increasing. Despite October’s US non-farm payroll outlook being a relatively positive one for the US (as payroll additions exceeded monthly expectations), payroll growth did slow to its lowest in five months, indicating the worsening of Covid-19’s adverse effects on the US economy.

WTI

Price of the WTI Crude Oil started the week at $36.81, rising to maximum of $39.15 on 4/11, before settling at a lower $37.46 on Friday. Oil prices fell as record reported cases of COVID-19 in the US and across Western Europe have impeded global demand recovery; consequently, additional lockdown and stricter measures in Europe have further exacerbated demand for crude and economic activity, in general.

The undecided US presidential election could also be a determinant weighing on prices, as election night turned into election week keeping markets on edge. Lastly, as voiced by Senate Majority Leader Mitch McConnell, there’s reduced likelihood of a large U.S. stimulus package as the 1% drop in the U.S. employment rate could indicate that Congress will enact a smaller COVID-19 stimulus package that is highly targeted at the effects of the pandemic; therefore, a moderated stimulus package will also weigh on demand for crude.


Trade Idea

Idea – Long GBP/USD

- Current Price Level: $1.3139

- Entry Price: $1.305

- Stop Loss: $1.295

- Take-Profit 1: $1.325, Take Profit 2: $1.34


Past Week (2/11/2020 to 7/11/2020) GBP/USD Outlook


Source: Trading 212


The figure above details the 1-hour chart for the GBP/USD in the past week. There were two significant bullish rallies observed, the first from Monday at 1.288 to late Tuesday at 1.313, and the second from 1.294 on early Thursday all the way to 1.315 by the end of Thursday. The second rally was more pronounced as the sterling sought to consolidate around the region of 1.313 to 1.315 for the rest of the week.

The midweek bearish trend reversal of the GBP/USD was attributed to a media report that the Bank of England was considering negative interest rates, while the second bullish rally coincided with the increasing likelihood for a Biden victory at the 2020 US Presidential Elections, which led to the weakening of the US dollar to a two-year low.

Technical Analysis

The long-term trend of the GBP/USD is expected to be bullish. Prior to this week, the pound hit the present resistance level of $1.31 on October 21 before finding support at $1.28 level on November 2. $1.28 support level rejected the price and it increased to test the same resistance level of $1.31. With current price levels above the MA10, MA20 and MA50 levels, it is an indication that the bulls are dominating this market.

An article by Cryptovibes, however, mentioned that in the 4-hour chart, the RSI Period 14 is at 70 levels with the signal pointing down – indicating that the pound is currently overbought and suggesting a sell signal. It is expected that the price will fall again early next week (Monday) to the key demand level of $1.30 – before the general bullish trend eventually breaks up the resistance level of $1.31 to new resistance levels of $1.32 and $1.34.

Let us now explore some fundamental and macroeconomic reasons that may potentially further support this bullish trend – which includes both maintaining a key support at $1.30 and a breakthrough of the current $1.31 resistance level.

Macroeconomic Analysis

Prospect of a Joe Biden Victory in the 2020 US Presidential Elections

As of 6/11/2020, Joe Biden is the odds-on favourite to win the 2020 US Presidential Elections. While he has yet to reach the 270 electoral votes necessary to claim victory, Biden currently enjoys healthy leads in key swing states of Nevada, Pennsylvania and Georgia – while only requiring one of the 3 abovementioned states for victory. With largely mail-in ballots yet to be accounted for, which should predominantly swing in favour of the Democratic party, it is safe to assume that Joe Biden will be the next President.

Update:

Major news outlets have declared Joe Biden as the winner of the 2020 US Presidential Elections (as of 7/11/2020). This was after Biden had come out triumphant in the key battleground states of Pennsylvania and Nevada. This win could weaken the dollar in the following ways:

Return to Stability in Policymaking

One of Biden’s immediate goals would be to reverse many of Trump’s executive orders and regulations, which may include strengthening the Affordable Care Act and labour protections. An intuitive return to a more stable and predictable policy-making regiment will reduce uncertainty among investors. Investors may then have the confidence to move from the safe havens of the dollar into emerging markets. This effect is expected to be pronounced by the rapid economic recovery from COVID-19 of many emerging economies. Comparatively, the economic recovery in the US is losing momentum amid the return of a second wave of infections that is expected to persist throughout the winter. This difference in economic recovery may exacerbate a move away from the USD.

Biden’s Tax Plan

One of Biden’s more controversial plans is his tax plan – which entails higher taxes to be paid by corporations and the wealthy. Biden intends to raise the corporate tax from 21% to 28%, while mandating individuals earning more than USD400K/year to pay additional payroll taxes. The increase in corporate taxation could weaken foreign demand on US equities, which would then weaken the dollar.

Diminishing Hope of Large Fiscal Stimulus (Opposite Effect)

However, the weakening of the dollar may be hampered due to diminishing hope on a large fiscal stimulus advocated by the Democrats. With Democratic challengers failing to oust key Republican incumbents in South Carolina, Iowa and Maine, it is likely that Republicans will retain control of the Senate. This will make it both difficult and cumbersome for the Democrats to pass the $3.5 trillion fiscal stimulus package they had been advocating for.

In theory, this large fiscal stimulus would have led to an even greater depreciation of the USD as it was likely to produce inflationary effects, which would then reduce the spending power of the currency. This would have led to a sell-off of the USD and further weakening of the currency. However, as this idea is looking at the medium term, it would have been unlikely for Biden to introduce this stimulus package within weeks, especially since the outcome of the election is still unclear. As such, I believe that the abovementioned 2 factors would help sustain a weak USD in the short run.


Potential of a Brexit-Deal (With not much impact should talks appear unsuccessful)

UK Prime Minister Boris Johnson and the European Commission President, Ursula von der Leyen, will hold talks on Saturday (7/11) to take stock of UK-EU negotiations. The PM remains hopeful that a trade deal with the EU could be agreed upon, and should talks be successful, this would lead to investor confidence in the GBP due to the possibility of a free-trade agreement. This was already observed in mid-October, where the pound surged on investors’ confidence that Brexit talks would resume.

However, it is important to note that a concrete deal that may lead to a pound surge is unlikely to be reached in the coming week. EU Chief Negotiator Michael Barnier had earlier conceded midweek that negotiators had failed to make breakthroughs on key sticking points such as future common standards and policing the final agreement. However, Barnier had later went on to admit that the EU must compromise on the bloc’s hard-line fishing demands to broker a Brexit agreement with Britain. This compromising stance from the EU is a potential source of optimism that a Brexit-deal could still be achieved even if talks over this weekend appear unsuccessful. It must be said that investors shrugged off Johnson’s no-deal Brexit speech a few weeks back, implying high investor confidence that a deal could be reached.

Release of UK Labour Market Data – Tuesday 10 November 2020

A further increase in demand for GBP may be observed if the latest set of UK labour market data is optimistic. Forecasts suggest an uptick in average earnings at the end of 3Q, with higher levels of wage growth boding well for the UK economy.

Even though the UK is currently on a month-long lockdown, the government had extended the furlough scheme, allowing workers to receive 80% of their salary through lockdown. This would help provide cushion to a potential free-fall in consumer spending, ensuring buoyant levels of demand in the GBP. A positive set of data on employment figures and economic outlook may be the final impetus to push the GBP beyond its current resistance level of $1.31, activating the first take-profit level.

Key Takeaways

Long the GBP/USD in the following circumstances…

- Selling signal is accurate and GBP/USD falls to support level of $1.30-$1.305 (However, do note that a confirmed Biden win may cause the GBP/USD to rally from the get-go, thus a fall back to the support level of $1.30 may not be observed).

- Improving investor sentiment as a result of a Biden Victory.

- Neutral/Semi-Successful Brexit Talks this weekend (8/11/2020-9/11/2020).

- Positive UK Labour Market Data on Tuesday (10/11/2020).


May not wish to long the GBP/USD in the following circumstances…

- Trump incites political instability in the aftermath of a loss – uncertainty may cause investors to lean toward USD as a safe haven – To this end, Trump has already declared that the election “is far from over”; mentions his campaign will challenge the results in court next week.

- Pessimistic UK Labour Market Outlook (E.g. Greater than expected (4.5%) unemployment figures).


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