Tuesday, September 29, 2020

GBP/USD may have some limited upside in the short-term despite medium-risks tilted to the downside

  • Dollar
  • Pound
  • Bank of England


Analysts’ Pick: GBP/USD may have some limited upside in the short-term despite medium-risks tilted to the downside

  • Short-term outlook for GBP/USD may be tilted to the upside on potential positive Brexit negotiation developments and reduced risk aversion in the US
  • But upside will likely be limited due to an expected spike in unemployment in the UK, and increasing downside risks for Covid-19 restrictions in the US
  • Details of the UK’s new Job Support Scheme will probably be unable to provide strong incentive to prevent layoffs from the expiry of the current furlough scheme
  • An upcoming flu season suggests that hospital occupancy rates remain key to prevent additional lockdown restrictions in the US

GBP/USD will likely be the focus for the week with a number of key economic data and macro events set. Cable may as a result see some upside this week, which may likely be limited by the growing number of Covid-19 infections in the UK along with an impending spike in unemployment. For the US, the presidential debate will be the highlight of the week, but we may not see strong volatility in the greenback immediately after since the level of uncertainty surrounding the outcome for the presidential elections still remains high. Jobless claims look likely to have minimal impact as well, while ISM's PMI reading may provide investors with some optimism later this week.

Post-Brexit trade negotiations appears to be making some progress, and it is looking increasingly more likely that we will continue to see more progress moving forward. Incentives for both parties continuing to remain broadly aligned, i.e. a post-Brexit trade agreement is better than none. This is due to the extent of damage from the pandemic to both the EU and the UK, and has already been signalled by weakening economic data, and reiterated by European Commissioner President Ursula von der Leyen on Monday night. The statement from Leyen signals that the EU is keen to make a deal despite trust in British Prime Minister Boris Johnson eroding after putting forth his Internal Market Bill - which the EU has also remarked that it will seek legal action if adopted.

A deep contraction to the UK and EU’s economy is likely to reduce the chances of a hard Brexit


The likelihood of a hard Brexit continues to look relatively low. The self-imposed deadline by Johnson for the UK and EU to come to an agreement by October 15th, when EU leaders meet for a summit, is likely to pressure negotiators as well and may serve as additional pressure in moving trade talks along. In addition, whether Johnson's intention for the Internal Market Bill was to serve as a safety net or as a negotiation tactic against the EU, we still maintain that the main factor is that it gives the UK additional leverage in terms of negotiation power due to a stronger alternative in the event of a no-deal Brexit. The Bill has already been supported by the House of Commons and will continue on to the House of Lords and is continually being supported by Downing Street despite threats of legal action from the EU. But the bill is not expected to come into law until later October or November (contingent on if the House of Lords where Johnson's party does not have majority pass the legislation) and may instead lead to constructive negotiations in the following weeks.  This should improve sentiment for sterling and possibly provide a boost to the currency.

The UK will more than likely experience an uptick in unemployment in the coming months. Chancellor of the Exchequer Rishi Sunak's new Job Support Scheme is set to replace the current furlough scheme from November 1st. The scheme will last for six months, but the importance is in the take-up rate of the programme, which we anticipate is more likely to be lower-than-expected. Sunak's scheme in our view is a sharp downgrade to the previous furlough scheme. For employees to be eligible, they must work a third of his/her working hours. As for the employer, the firm must pay the employee for the hours that the employee has worked (33% of total hours) as well as another third of the employee's remaining normal wages. To put it more simply:

Percentage allocation of  payable wages under the scheme


As a result, there appears to be little reason for companies to retain full-time employees to work for 33% of output (in terms of time) and pay them 55% of their wages. On the flip side, employees are also unlikely to work for more than 77% of their normal working hours since only 77% of their wages will be paid. This would mean that the take-up rate will likely only be limited to employees who are willing to take up pay cuts, and employers that are willing to give up output. Hence, we expect the new Job Support Scheme to only provide limited support to both unemployment and household income over the next six months. This should increase the incentive for the Bank of England to ease monetary policy further - likely in the form of an expansion to asset purchases - by the end of the year, which will likely put downward pressure on the currency, but only in the medium-term.

For the dollar, the drivers for the week will likely be risk sentiment, labour market data and ISM's manufacturing PMI data. While the greenback has shown a strong rebound in the past three weeks, our view is that risks continue to skew the long-term outlook for the dollar towards the downside. Risk sentiment has been a strong driver for demand in the dollar over the past two weeks due to the high levels of selloffs in the equity market, which at one point saw the S&P500 dip back below into negative year-to-date performance. But we are starting to see alleviated risk aversion in the markets, most notably with the VIX index returning back to levels seen just before the spike up in early September. That said, VIX still remains higher than longer-termed averages due to high levels of uncertainty surrounding Covid-19 and the US presidential elections.

VIX has fallen but remains above its one-year average despite falling below the 100-day moving average


Initial jobless claims will likely continue to show a slight decline as it continues to hover at extreme levels. Layoffs will likely be limited by the imbalance in economic recovery among sectors in addition to growing uncertainty of additional fiscal stimulus measures from the US government. Continuing claims in contrast may show an accelerated decline, although this will be more due to the maximum limit of 26 weeks of benefits that some states impose. Claims data as a result should have minimal impact on the dollar.

Continuing claims likely to continue to decelerate as a result of the 26-week limit imposed by states


More important will be September's payroll report on Friday, which will likely also show a slowdown in jobs growth. August saw a large incline in payrolls, boosted by jobs for the 2020 Census. That driver is set to start to fade moving forward and may see an additional decline of roughly 40,000 in September. In addition, the lack of new fiscal stimulus measures will probably weigh on business sentiment and consequently job creation and job retention. While overall Median forecasts' point to a 830,000 increase in NonFarm payrolls, we expect a more conservative figure at about 600,000 with the bulk of employment coming from a spike in incentives for Americans to find jobs due to the expiry of the weekly top up of US$600 in enhanced unemployment benefits. Jobs growth is still likely to help put downward pressure on the dollar, although we expect it to be minimal as well.

The general outlook from ISM's August survey suggests that an expansion is likely to continue for September, with signs of an impending pull back surfacing sometime in Q4 2020. Expansion in adjusted regional manufacturing indices suggests that it is likely that September will see another expansionary in ISM's headline figure as well. Multiple mentions of an undersupply in August's reports signals that a number of industries remain bullish on demand in the short-term which is likely to boost production in anticipation of a shortage of supply due to delayed supplier deliveries. However, it was also evident that an expansionary period will likely face difficulty as we approach the end of the year, most notably with the machinery industry signalling that customers were still uncertain on how long the recovery in demand can last. We expect a closer to 57.0, similar to economists' forecasts of 56.0. This should help to fuel investors' optimism over the week, which would imply a weaker dollar as a result.

Finally, the pace of new Covid-19 cases in the US has also shown signs of rebounding back higher as we move into the fall, highlighting the importance of hospital capacity. As the flu season approaches, the concern will be keeping hospital capacity under control as flu cases start to rise in the US. Masks should help alleviate this, but this also means that states without strict requirements for people to wear masks will be at higher risk. Notable states in concern are Alabama (ICU Occupancy: 81%, Covid-19 Positive Rate: 12.7%), Texas (ICU Occupancy: 81%, Covid-19 Positive Rate: 7.5%) and Florida (ICU Occupancy: 76%, Covid-19 Positive Rate: 10.7%). This signals that we may see additional reintroductions of Covid-19 restrictions as we move forward to help alleviate the pressure on the health care system, which will likely put additional pressure on the US economy.

US states with positive Covid-19 rates above 7%


Hence, GBP/USD may have some upside in the short-term on potentially positive developments on the Brexit front and on a weaker dollar thanks to improving risk-on appetite among investors. Cable may be able to retest the resistance at 1.2976's level as a result, but may not be able to exceed that as it may start to form a tighter range due to uncertainties in the global economic landscape. Over the medium-term, there may be room for the currency pair to fall back lower thanks to an additional wave of layoffs in the UK and increased volatility pushing demand for the dollar higher on increasing Covid-19 cases in the US and uncertainty on the presidential elections.

Technical Analysis:


Cable dipped back below its 50-day moving average, as it slips back into a bearish trend. But its rebound at the support at 1.2733 suggests that bulls are likely to try to retest the resistance at 1.2976’s level to push the currency to trade closer to the 50% Fibonacci retracement. This is supported by MACD which signals that the currency pair may be starting to experience upward momentum in the short-term. Short-term fundamentals may be the catalyst for bulls to retest the 1.2976 resistance, but with risks skewed to the downside, we may see traders try to retest the RSI support level of 34.52 in the medium-term.

Support: 1.2723 / 1.2551 / 1.2298

Resistance: 1.2976 / 1.3148 / 1.3382

GBP/USD Chart (D1)