Trade Of The Week: GBPUSD To Plunge Deeper Into Abyss?

Our trade of the week was initially reserved for the mighty dollar after the bloodbath in FX markets last week…

However, the pound’s flash crash to record lows hijacked our attention early this morning.

It’s been a rough month for the British pound thanks to a growing list of negative themes.

The economic outlook remains uncertain in the face of rising inflation while the death of Queen Elizabeth II has added to the overall gloom. Sentiment towards the UK economy is shaky despite the BoE recently hiking rates by 50 bp to control inflation. Investors are clearly on edge and this continues to be reflected in increased pound sensitivity to political and economic developments.

The low down…

The key trigger behind the pound’s stomach-churning selloff was the Conservative government’s huge tax-cutting mini-budget revealed last Friday. Growing concern over the fiscal policies fuelling inflation and government debt left investors on edge, adding another layer of uncertainty over the UK’s already gloomy outlook. Chancellor of the Exchequer, Kwasi Kwarteng’s comment on Sunday that there will be “more to come” on tax cuts, simply rubbed salt into the wound – sending the pound sliding to a record low at 1.0350.

With the fundamentals and negative themes clearly favouring pound bears, the path of least resistance for GBPUSD points south.  As the dollar continues to appreciate on Fed hike bets and risk aversion, this may fuel the downside momentum.

What does this mean for the Bank of England?

The pound’s painful depreciation has sparked speculation over an emergency interest rate hike from the BoE to calm markets. Even if the BoE intervenes, short-term gains may be swallowed by long-term themes favouring bears.

According to Bloomberg, traders are pricing as much as 125 basis points of tightening by the next policy meeting in November, springboarding the BoE into the super jumbo hiking club. While such a move could throw the tired pound a lifeline and limit downside losses, the upside could be capped by recession fears and other forces haunting attraction towards sterling.

What to watch out for this week…

This will be a week jampacked with speeches by numerous Federal Reserve officials. The next few days could be incredibly volatile for the dollar which remains highly sensitive to anything relating to inflation and rate hike expectations. If the majority of Fed speakers strike a hawkish note and fuel speculation around more aggressive rate hikes down the road, this could turbo-charge dollar bulls further. Alternatively, a cautious set of Fed officials who drop dovish hints and concerns over the US economic outlook could slam the breaks on the dollar rally. Such a development may invite bears into the scene, dragging the Dollar Index (DXY) lower.

Ultimately, a stronger USD may drag the GBPUSD to fresh all-time lows while a weaker USD could offer space for bulls to fight back – triggering a technical bounce on the currency pair before bears return.

GBPUSD parity dream to become reality?

After hitting an all-time low of 1.0350, the GBPUSD was only 350 pips away from touching parity.

When considering how the currency pair dropped over 400 pips on Friday and well over 1000 pips since the start of last week, the parity dream could become reality sooner than expected.

Prices are under intense pressure in the daily, weekly, and monthly timeframe. Given are we are trading in uncharted territories, there is plenty of space for bears to run rampant. The previous all-time low at 1.0520 (hit back in 1985) could transform into dynamic resistance down the road. Sustained weakness below this point may re-open the doors back towards 1.0350. A breakdown below this level could encourage a selloff towards 1.0100 and parity.

Alternatively, if prices break back above 1.0850 this could trigger a move higher towards 1.1350 where bears may attempt to snatch back control.

On the daily charts, things look ugly. Prices are trading below the 50-, 100- and 200-day SMA while the MACD is below zero. A move back below 1.0520 could signal further declines over the next few days. If 1.0850 proves to be unreliable resistance, the GBPUSD could challenge 1.1300.