GBPUSD Monthly Technical Forecast
The rally from 1.35 in the GBPUSD is probably just the beginning of a 4th wave correction. 4th waves commonly unfold as triangles. In this case, Cable would trade in a tightening range (at lower levels) for probably the rest of the month. Immediately, expect weakness in wave d of the triangle towards 1.40. Bottom line; a consolidation and break below 1.35 looks likely before an important low is in place.
GBPUSD Interest Rate Forecast
Now that the BoE has brought their benchmark rate down to a record low of 0.50% we have seen the interest rate expectations spread between the U.K. and the U.S. shrink considerably. Credit Suisse overnight index swaps have gone from pricing in another 12 bps of cuts to a 39 bps increase for the U.K. which has reduced the difference in expectations from -53 to +6.
Although this is a bullish signal, with interest rates near zero, they have lost some of their predictive value for currency pairs. Nevertheless, improving fundamentals and stabilizing inflation in both countries will lead to increasing interest rate expectations Nevertheless, improving fundamentals and stabilizing inflation in both countries will lead to increasing interest rate expectations. If the U.K. shows signs of emerging from the downturn first then the pound may see its yield advantage increase over the coming months which could be bullish for the pound.
British Pound – US Dollar Valuation Forecast
Aggressive selling over recent months has seen the British Pound slip below its PPP exchange rate into undervalued territory. All signs point to the likelihood that the disparity will intensify before prices move back in the opposite direction as the US Dollar continues to be highly correlated with trends amid what the IMF expects to be the worst global downturn since the Second World War. The international lending body has further forecast that the UK will see the deepest recession of the G7 nations, suggesting rates will be comparatively slow to move back higher and giving the greenback an additional advantage. While the bottom line is bullish from a strict valuation standpoint, it seems prudent to remain on the sidelines for the time being until a greater value gap emerges.
What is Purchasing Power Parity?
One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by the Organization for Economic Cooperation and Development (OECD). We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar. Currencies pairs that are undervalued against their PPP exchange rate have the size of the value gap denoted in RED, while those that are overvalued are denoted in GREEN.
