Three factors have combined to create a GBP recovery in recent weeks.
- Brexit sentiment has moved in favour of “Remain”.
- Positioning was extremely short GBP and has been squeezed
- Global risk sentiment has improved.
However, going forward, the scope for generalised GBP gains is now severely diminished. It should not be forgotten that he case for GBP weakness was not based entirely, or even primarily, on Brexit, but on the combination of overvaluation, declining growth outperformance, and a severe current account deficit problem. While GBP weakness in Q1 did reduce the overvaluation issue, it didn’t eliminate it, and after the recent recovery GBP still looks overvalued. Sluggish growth and a big current account deficit remain an issue.
Of the three factors that have helped GBP to recover, the improvement in the fortunes of “Remain” may be the most important, but has probably gone as far as it can. The FT poll of polls below illustrates that the recent uptick in the fortunes of Remain isn’t decisive, and the movement in the bookies’ odds to about 75% in favour of Remain looks like an overrreacction. There is a lot of water to flow under the Brexit bridge yet, and the Scottish referendum underlined the risk of a late swing. Even if Remain stays ahead, I don’t see the Bookies’ odds improving much from here, suggesting risks are on the GBP downside.
While the CFTC data don’t, as of last Tuesday, show any real reduction in GBP shorts, GBP/USD was below 1.44 at that point and I suspect there has now been a significant reduction in short positioning, though probably not a complete reduction. Option positioning is obviously still largely extant, but with strikes generally well below here, the tendency now will be for GBP moves down to be much more amplified that GBP moves up.
The improvement in global risk sentiment has helped GBP, and I don’t expect this to reverse, but expect GBP correlation with risk to fade. The recovery in commodity prices and producers may have helped GBP via the heavy weight of commodity companies in FTSE, but any further equity strength seems likely to be more broad based. I continue to see more value in the Eurozone.
Practically, I would look for a dip to round 0.7680 to buy EUR/GBP. For now, with Q1 US GDP likely to be quite weak, I would not favour the USD, at least until that GDP number is out of the way (released tomorrow Thursday 28th). The Atlanta Fed model is currently looking for 0.4% (annualised, so 0.1% in UK money) and the market expects 0.7%. However, anything above 1.48 would represent value to sell GBPUSD.