Sterling: Where Do We Go From Here?

Our limit to sell at $1.4670 as planned in our May 4th article was filled on May 25th, and as of this writing the trade is on a risk-free ride, though we expect a rebound ahead on the daily uptrend channel that the GBP/USD exchange rate is about to encounter.

The recent rise in sterling was primarily due to short covering and improved polls on the ‘Brexit’ referendum, where Oddschecker marked that 58.53% votes favor to ‘stay’ in the EU while 41.47% favor to ‘leave’.

GBP/USD Charts

It seems that President Obama’s visit and Bank of England’s warning of a systemic downside risk recently, dubbed ‘Project Fear’ by the pro-leave campaigners, have started to pay off. In early May, Bank of England warned that the decision to leave EU could cause a sharp slowdown in economic growth leading to recession, resulting in job loss for many and a possible skyrocketing inflation. BoE indeed has reduced it’s growth forecast by 0.2%, to 2% for 2016 and 2.3% for 2017 and 2018.

The latest imminent threat is from Spain, that warned the closing of the border with Gibraltar, a land mass viewed as “illegal occupation” - which was captured by the UK in 1704 - by Madrid. Spain may try to exploit the EU referendum as it said it would no longer have to respect the directives from Brussels on the free movement of capital, goods and workers to Gibraltar through it’s border if UK leaves the EU.

Yesterday, UK voters dropped a bomb when suddenly The Guardian ICM polls showed that 52% of voters surveyed want to leave the EU, while 48% favored to remain in the economic block. The sudden swing change saw the exchange rate dropped by more than 250 pips and US rate hike probability to fall back to 15%, as markets doubt that the Fed will hike rates in the midst of all this drama that could lead to a financial market meltdown.

FedWatch

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Over to the United States, the Fed is more hawkish than expected, as minutes of the latest FOMC meeting reveal that the Fed is almost certain to raise the rate for the second time in June, if all economic data – especially GDP, inflation and employment – are in order to warrant the hike.

Recent GDP reports support the move, as the first quarter of 2016 recorded a 0.8% growth, higher than 0.5% recorded in the last quarter of 2015. Inflation was 0.1% higher than expected, with 0.4% in April versus only 0.1% reported in March.

The next report markets look forward to seeing is the NFP report this Friday, that expects a meager 3,000 job additions from 160 thousands added last month. Though the unemployment rate is expected lower at 4.9%, compared to 5% previously.

Looking at the latest CoT report, sterling saw the biggest short covering with 5,587 shorts reduced, bringing the net shorts to about -38,200 contracts.

Sterling Futures CoT Chart

On the institutional side, Morgan Stanley (NYSE:MS) has reinstated their short, targeting $1.37, leveraging on the ‘Brexit’ issue. SEB of Sweded on the other hand is bullish, expecting markets to resume focus on the economy and outlook, citing recent inflation and employment data showing no sign of rising costs that warrant a policy tightening this year.

In the likely event the UK stays in the EU, SEB targets GBP/USD at $1.49 by the end of June.

Halal Traders holds the short and will continue to move the stop in our favor.