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The clock is ticking in the U.K. Theresa May has about a week to prevent her government from falling apart. In her speech this past week, the Queen set a one week deadline for the House of Commons vote and if May doesn’t strike a deal with the Democratic Unionist Party by then and loses the vote, she could be forced out of power. This catastrophic outcome would create major political uncertainty that could send GBP/USD back down to 1.26. Although the Tories are optimistic, the DUP is pushing back hard with the party refusing to answer May’s calls for 36 hours and demanding GBP 2 billion for Northern Ireland’s infrastructure and healthcare programs. Apparently they even held “secret talks” with the Labour and Liberal Democrats to pressure May into accepting their demands. Chances are she will cave to the DUP just as she is beginning to cave to the European Union on Brexit talks. With no major U.K. economic reports scheduled for release in the coming week (GDP is generally not revised), Brexit negotiations, the House of Commons Vote and DUP coalition talks will drive sterling trade. Although GBP dropped to 2 month lows after Mark Carney speech this past week – he said it is not the right time for a rate hike, it bounced back quickly on hawkish comments from BoE Chief Economist Haldane. Carney is worried about Brexit uncertainty and wage growth but Haldane believes that a hike would only offset part of August stimulus. Although he did not vote for a rate hike, his close alignment with the 3 members who voted for immediate tightening earlier this month leads investors to wonder who else could be pondering a hike. In the meantime, the political stakes are high and the level uncertainty leads us to believe that GBP will resume its slide back to 1.26 as political troubles often translate to economic ones especially as Brexit and a hung Parliament makes it difficult for the UK economy to grow enough to warrant a rate hike this year.
Technically, GBP/USD bounced off the 100-day SMA this week but as long as it holds below the spike highs near 1.2830, the downtrend remains intact. We like selling between 1.2750 and 1.2800, where the 20-day SMA and 23.6% Fib retracement of October to May rally lie.