It's all about the Sterling

June 13, 2017 09:50 AM

The Sterling nudged higher during Tuesday’s trading session as investors made an effort to accept the reality of last week’s shock UK election outcome which resulted in a nightmare “hung parliament”. Regardless of the current upside gains, the British Pound remains vulnerable to heavy losses with the outlook tilted to the downside as political instability in the UK weighs heavily on the currency.  This period of uncertainty is likely to leave investors on edge as questions are raised over the impact the general election results will have on Brexit negotiations.

Although a hung parliament has heavily restricted May’s ability to deliver the hard Brexit that some had feared, and has even sparked optimism for a softer exit from the European Union, Sterling continues to be overshadowed by the current instability in Westminster.

Theresa May seeks DUP lifeline 
With the conservatives, eight seats short of forming a government, UK Prime Minister Theresa May has turned to the Democratic Unionist Party (DUP) for support in a bid to staying in power. Although Sterling could find itself buoyed in the short term if May secures a deal with the DUP on Tuesday when parliament sits for the first time since the election, I feel it may have little impact on the longer term bearish bias. Even if Conservatives are able to achieve the eight seats needed to pass laws in parliament, this is still a far cry from the strong and stable government which was promised in the election campaign.

Political instability delays Brexit talks
Recent reports of the EU’s Chief Negotiator, Michel Barnier, and UK’s Secretary of State for Exiting the European Union, David Davis, failing to reach an agreement on an official date for opening Brexit talks has fanned fears of complications in the early stages of the negotiations. With political instability in Westminster potentially complicating and adding more pressure to Brexit talks, which already has a tight deadline, the UK remains in a vulnerable position. With negotiation dates now up in the air and the UK government desperately attempting to stabilize, it will be interesting to see how the European Union reacts.

UK inflation hits 4-year-high 
The Brexit-inspired currency depreciation has propelled inflation in the UK to uneasy levels with consumer prices hitting a four-year high at 2.9% in May. With wage growth failing to keep up with inflation, consumers are likely to feel the pinch which may fan concerns over the sustainability of the UK’s consumer-driven economic growth.

Are Sterling bears back in town?
The bearish price action on Sterling since the election outcome last week suggests that those who were passionately bullish on the currency could be having second thoughts. With Theresa May’s gamble to strengthen her hand ahead of the Brexit negotiations backfiring and sparking chaos in Westminster, the British Pound remains vulnerable to further downside.

From a technical standpoint, the British pound/U.S. dollar (GBP/USD) currency pair is heavily bearish on the daily charts. Previous support around 1.2775 could transform into a dynamic resistance that encourages a decline towards 1.2600.

Dollar edges lower ahead of FOMC
The main event risk for the Greenback this week may be Wednesday’s heavily anticipated Federal Open Market Committee statement. With the CME Group’s FedWatch tool showing a near 100% probability that the Federal Reserve will raise U.S. interest rates in June, most of the focus may be directed towards when the central bank will next raise U.S. interest rates in 2017. A lack of clarity from the Fed regarding future monetary policy and interest rate hike timings may pressure the U.S. dollar further. From a technical standpoint, the Dollar Index remains pressured on the daily charts. A breakdown below 97.00 should encourage a further depreciation towards 96.50.

WTI Crude hovers above $46 
Oil prices were slightly supported during Tuesday’s trading session after Saudi Arabia stated that it would make export cuts in July in an effort to tighten oil markets. While short-term bulls may benefit from the speculative boosts in prices caused by Saudi Arabia’s statement, this does not change the longer term bearish dynamics. With oversupply concerns a key theme, and there still being a risk of U.S. shale production sabotaging OPEC’s efforts to rebalance the oil markets, sentiment towards the commodity remains bearish. Technical traders may see the price fail to stabilize above $46 with repeated weakness below this level opening a path towards $45.

About the Author

Lukman Otunuga is an FXTM research analyst