TSX higher on employment data
Sterling (GBP/USD) has been resilient in the face of soaring gilt yields, but cracks are starting to show. With growth weak, inflation sticky, and fiscal policy under scrutiny, the risk is further downside in GBP if long bond stress persists.
- UK gilt curve steepens sharply on fiscal worries
- Long-dated yields at highest levels this century
- Pound starting to slide alongside gilts
- GBP/USD and GBP/CHF setups point lower
GBP Outlook Summary
Considering apparent market anxiety over the United Kingdom’s long-term fiscal trajectory, leading to a sharp steepening in the gilt curve as traders demand ever greater levels of compensation to account for perceived risk, the British pound has not suffered anywhere near as much as you would expect.
Yet. That may reflect concerns not only about the fiscal trajectory in other advanced economies but also unease about the loss of central bank independence, especially in the United States. Despite the uncertain and rapidly shifting macroeconomic backdrop, for now, technicals continue to offer as good a guide as any on how the pound may fare against other major developed currencies.
Long Bonds Rupturing Higher
Like a fault line rupturing during an earthquake, long bonds around the developed world have been hit hard over recent weeks, fuelled by concerns about unsustainable fiscal deficits, evidence that central banks are prioritising economic growth over inflation, along with dwindling demand for long-dated debt due to both structural and valuation reasons. As concerns have flared in one nation, they’ve tended to spread to others, dragging the yield curve higher across the entire G7 complex.
For the UK, where budget concerns were never adequately addressed following the gilt market meltdown of September 2022, the impact has been particularly acute, leaving 30-year and 40-year yields at levels not seen this century.
Source: TradingView
The differential between 30 and 2-year yields is now the widest since 2016. While this sometimes indicates that expectations for nominal economic growth are picking up, which would be bullish, in this instance, it reflects a greater risk premium being demanded by traders to fund the U.K. government’s longer-term.
Given the stagflationary environment the U.K. economy finds itself in, with seemingly no real plan to reduce the budget deficit beyond raising taxes, given an inability to cut expenditure, who could blame them? It also explains why the British pound has started to sink alongside the gilt market, drawing comparisons to what’s regularly seen in developing economies reliant upon the kindness of others for funding.
The government’s struggles to match expenditure with revenues so that new borrowing can fund investment is a vulnerability markets may attempt to exploit far beyond what’s been seen so far, especially if concerns are not addressed imminently. Until that point, the pound is likely to remain pressured.
GBP/USD Teeters on Support
Source: TradingView
GBP/USD now finds itself perched on horizontal support at 1.3370 having printed a bearish engulfing candle on Monday, taking out uptrend support from the August 1 low in the process. With RSI (14) trending lower and beneath 50, downside momentum is building. MACD has also staged a bearish crossover, albeit above zero, bolstering the prospects for downside.
Beneath 1.3370, there’s not a lot of visible support until 1.3142. The price did some work around 1.3300 in August, so that should be on the radar should cable crack. Beneath 1.3142, the 200-day moving average and 1.2870 are levels to watch. Should support at 1.3370 hold, as was the case on Tuesday, topside levels to focus on include the 50-day moving average and 1.3589. In this environment, selling rallies and bearish breaks is favoured overall.
GBP/CHF Downside Risks Build
Source: TradingView
From a fundamental perspective, GBP/CHF is another pair to keep an eye on given the vastly different trajectory for government debt levels in both nations. One look at the chart tells you that when market conditions really deteriorate, downside can occur quickly.
Having failed to sustain bullish moves above 1.0850 for much of the past fortnight, bulls were eventually overrun on Tuesday, seeing the pair break support at 1.0800. The engulfing candle printed warns of downside risks—a view backed by momentum indicators which are generating increasingly bearish signals, along with the downtrend the pair now finds itself in.
With 1.0800 broken, it may now act as resistance, providing a level for shorts to be established with a stop above for protection, should the price bounce from current levels. 1.0673 screens as a potential target for bears, coinciding with where the price bounced on several occasions in late July and early August.
A sustained breach of that level would bring a retest of 1.0612 into play. Above 1.0800, the 50-day moving average, 1.0850 and 1.0950 are levels where offers may emerge.