When the fear goes away, euphoria comes in. Investors have been selling the sterling, concerned about messy Brexit, for 2.5 years. As soon as the threat receded, even neutral news has been seen as a signal to buy something that is pretty much cheaper. The largest assets manager BlackRock (NYSE:BLK) suggests that the markets are too self-confident, and the UK withdrawal from the EU without a deal on March 29 may result in the pound losing about a quarter of its value.
Nevertheless, the euphoria pushes the GBP/USD up above level 1.3.
The rally was triggered by the report on strong UK employment and Labour’s announcement to support a delay in the official Brexit date. The UK unemployment rate has dropped down to its lowest level since 1975, and the average wages growth has performed the best result over the last decade. So, the Bank of England is getting more likely to raise its Bank rate in case the political environment improves. According to Bloomberg Economics, if London and Brussels extend the term of withdrawal for three months, the UK economy will expand by 1.5% in 2019, not meeting the BoE forecast of 1.7%, suggesting the deal with the EU. If the uncertainty last half a year, the UK PMI is down as well as business activity, the UK GDP rate will hardly rise above 1.3%.
If the GBP is getting stronger, it will hold back already weak inflation rate and BoE will have no reasons to tighten its monetary policy. The UK economy doesn’t look perfect, higher borrowing costs will only harm it. Therefore, the GBP/USD current rally results from stabilization in the financial markets and closing of the pound short positions. It is impossible to see statistics on the latter due to the U.S. government shutdown; however, some banks’ studies prove that hedge funds are exiting shorts. Such position tracker of BNP Paribas (PA:BNPP) estimates the size of GBP short positions in the week, ending January 21, at -18 on a rating from -50 to +50. The five-day earlier, it was about -23, and by the end of December the figure was at around -30. Furthermore, a drop in volatility, and higher GBP/USD risk reversals, at 7-year highs, suggest the markets believe in the sterling’s prosperous future.
Source: Reuters
In my opinion, the pound is rising on expectations that Article 50 of the Treaty of Lisbon will be extended at the meeting on January 29. Besides, the risks of profit-fixing for the five-week rally are growing. An uptrend that is not regularly supported by macroeconomic statistics amid the continuous uncertainty is not a strong foundation for the GBP bulls. Nevertheless, the worst for GBP is probably over. The GBP/USD rate can well rise as high as 1.35-1.36 over the next 6-9 months. So, it makes some sense to use the rollbacks to open long positions.