Major Reversal in GBP/USD

Major Reversal in GBP/USD

Fundamentals

GBP/USD experienced a major intraday reversal on Tuesday that erased all of last week’s gains and put the currency pair at its lowest level since March. The sell-off was driven by the combination of weaker U.K. data, stronger U.S. data and concerns about Scottish independence. At the end of last week, we said that sterling could rally if this week’s PMI reports surprise to the upside, reflecting a turnaround in the U.K. economy. Unfortunately while construction sector activity accelerated significantly, manufacturing activity, which is far more important slowed. The service sector PMI index is scheduled for release tomorrow and if it also falls short of expectations, then there is no data to support the call for earlier tightening by U.K. policymakers. In that case, the Scottish referendum and the inconsistency between data and policy should drive sterling even lower. At the same time, the U.S. dollar traded higher against most of the major currencies with the trade weighted dollar index climbing to its strongest level since July 2013. While a pick up in manufacturing activity, construction spending and economic optimism contributed to the move, the primary catalyst for the strong performance of the dollar was the sharp rise in U.S. yields. Ten year Treasury rates rose 8bp today, the last time we saw a move of this magnitude was in April, on a day when many Fed officials including Janet Yellen spoke on the economy and monetary policy. Investors are hoping that today’s sharp rise in U.S. yields will mark a bottom for U.S. rates. As economic and monetary policy divergence between the U.S. and the rest of the world widens, the dollar will become more attractive to foreign investors, providing room for further gains. As we noted in the past, the voracious demand for dollars stems not from the impressiveness of the U.S. economy but from the lack of better alternatives. However at bare minimum the prospect of a stronger non-farm payrolls report on Friday should keep the dollar bid and GBP/USD in a downtrend.

Technicals

Having broken below the August swing low, the next level of support for GBP/USD is the March low of 1.6462 and below that there is no major support until the 38.2% Fibonacci retracement of the 2013 to 2014 rally at 1.6285. A break back above 1.6645 would be needed to negate the downtrend.

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