Sterling opportunities ahead of Brexit vote

Ahead of the UK’s EU referendum in June, the possibility of a Brexit throws up opportunities in the forex market. Here’s a look at GBP/USD and GBP/EUR.

Canary Wharf
Source: Bloomberg

Ahead of the UK’s referendum on continued EU membership, the possibility of a Brexit is dominating sentiment surrounding the pound. The FX market is arguably one of the most responsive to economic affairs and as such, monthly IN_GBPUSD volatility in the first quarter of 2016 has been notably higher than in the second half of 2015. Further strong moves are expected in the lead up to the referendum.

GBP/USD

Looking at the monthly IN_GBPUSD chart, it is clear that by historical standards the pair is seriously cheap. Over the past 30 years, GBP/USD has never been lower than its January 2009 low of $1.3504. Typically, cable bottoms within the $1.4230-$1.3504 zone rather than at any single reliable level. The early 2016 sell-off did move into this zone, falling to the approximate middle before rallying sharply higher since.

With polls indicating growing support for the ‘remain’ campaign, traders will see these levels as straight out of the bargain basement. Considering the UK is moving towards a tightening monetary policy stance, sterling is highly likely to be significantly higher in four months’ time should the UK remain within the EU.

Of course there is the possibility of another leg lower for the pair, but $1.3504 is a likely backstop to any such move. To the upside, the key resistance levels to watch out for are $1.4566 and $1.5930.

Looking at shorter timeframes, the daily chart provides us with clues that this rally could be on the cusp of really taking off. The inverse head and shoulders pattern has been completed with the trendline break last week. However, the $1.4514 level is crucial as a strong bullish signal for the pair. The target from this inverse head and shoulders pattern is $1.5170.

GBP/EUR

Comparing sterling against the euro means also factoring in the interest rate differential, with a higher rate meaning that longer term GBP/EUR longs would benefit from the carry trade aspect of the trade. That being said, given the historically low rates in both countries, this is unlikely to be a major benefit. On this occasion we will look at these currencies with sterling as the base currency to allow us to focus on the pound.

The weekly chart shows that we have seen a sharp bounce from €1.2309. This is an important level for two reasons. Firstly, this is the 50% retracement of the 2008-2015 rally, and secondly it is the projected target from a major head and shoulders pattern formed at the turn of 2016. 

On the daily timeframe, there is a clear trend change in play, with price breaking through both the descending trendline and 50-day simple moving average last week. However, the most important factor was the close above €1.2770, which represents the first closed candle higher high since November 2015.

This also plays into the theory that we could see sterling rally heavily in the lead up to the referendum. Key resistance levels of note are €1.3067, €1.3355 and €1.4300. To the downside, a break below €1.2309 would negate this bullish view.

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