The Letter L, GBP Continues Recovery

Things have continued to calm down, with currency fluctuations having diminished for now. Actions by central banks, namely the Fed helping shore up USD liquidity, are working for the moment. But there are still far more questions than answers out there at this time, as to how the twists and turns of the coronavirus will play out, and what it will mean for the various regions of the globe both socially and economically.

Governments are starting to discuss plans to reopen. The course of navigation is far from certain; open the economy too soon and another round of shutdowns could quickly occur should the virus flare up again, but wait too long and the economic damage could become too great to overcome any time soon. And even when economic engines start to fire up again, people will almost certainly proceed with caution as to how they go about their lives and manage their finances. When the skies start to turn blue again, the confidence-building period is likely to be gradual. The hopeful ‘V’ shaped recovery is more likely to resemble an ‘L’.

With that said, we maintain that it is prudent to continue moving forward with caution, keeping FX policies reflective of our new uncertain world.

Clarity is lacking in FX markets; one doesn’t need to look any further than the relatively directionless price fluctuations. But this will change and give-way to discernable themes that provide us with the confidence to adjust our outlooks more aggressively.

FX volatility has backed off from its recent peak, but we hold firm that in Q1 we entered a higher volatility regime that is anticipated to last through at least the end of next year. With that in mind, we don’t look for volatility to drop much further from here and a higher range is seen to be sustained. A higher volatility regime doesn’t mean the world has to be falling apart, it can simply mean that FX markets are in the process of seeking out new paths of least resistance.

JP Morgan G7 Volatility Index (higher range of volatility expected)

The US Dollar is sitting smack dab in the middle of the March range. The feeling is that we will see a resumption of the broader trend higher, but it may take a little time to develop.

Outside of emerging market currencies, the euro currently looks especially exposed. The outlook for the euro was already weak before the virus struck, and with its arrival it has only weakened the backdrop for the structurally challenged euro-zone. The floor to keep a close eye on is the March low at 1.0697. A break below is seen as putting EUR/USD in jeopardy of parity and worse. Stay above noted floor and the outlook will remain neutral. Long-term we remain quite bearish the euro, seeing 0.8000 as well within the realm of possibility.

Cable is holding up well these days. Perhaps once the dust starts to settle, we may be able to return to our view that sterling could be one of the relative winners versus the dollar. “Relative” being the important word here as sterling could still fall against the dollar but rise versus everyone else. Prior to the pandemic the UK economy appeared to be ready to build momentum, but that idea is out the window.

GBP/EUR back to the top of the range? The cross is trying to trade back to the top of the 2016-present range at 1.21, which if it can accomplish this it will bring in another important test for the cross. The 3.5-year range will break at some point, and when it does the driving forces behind the new trend will likely be within our grasp. For now, floating mid-range leaves both sides exposed.