With the UK seeing massive success with their mass vaccination program, GDP growth is expected to rise as economic activity picks up. This is a bullish driver. But how do their neighbors in the Euro Area fare? Economic divergence in our fundamental analysis suggests that we may have a great trade setting up.
Macro Currency Strength Meter Neutral
GDP Differential Indicator Bearish
Trade Analysis (Imports & Exports) Neutral
Interest Rate Differentials Bearish Domestic Stock Market Analysis Bearish Hedge Fund Positioning Bearish Price Trends Bearish
Macro Currency Strength Meter - Neutral
Our Macro Currency Strength Meter is giving a neutral result for the EURGBP Pair. While the scores for both are trending downward, there is a spread between them. The EUR scores are higher than the GBP scores.
This presents a neutral outlook as they are both trending downward at roughly the same rate, maintaining an even spread.
However, if a divergence is created, either through negative European data in our leading or coincident indicators, or through positive new data for the United Kingdom, this can be very supportive, if not a catalyst for our trade idea.
GDP Differential Indicator - Bearish
Our GDP Differential Indicator suggests that the GDP of the Euro Area has begun to decline. However the same can be said about the GDP data for the United Kingdom. They both seemed to have followed the same path throughout 2020 and into 2021, with more volatility seen with the UK data.
We need to look even further forward to add conviction. However, this indicator does suggest that there is higher value behind the UK as the GDP score is higher. This would be supportive of our Bearish outlook on the EURGBP pair.
But let's look deeper
In the table representing the Global Economic Outlook from the IMF, we can see that the Euro Area is expecting to rise from -7.2% GDP growth last year, to 4.2% this year. But what we are looking at is the drop in the expected rate of growth to 3.6%. This is in sharp contrast to the expectations from the United Kingdom.
The expected rate of growth for the UK is not only higher than that of the Euro Area, at 5% in 2022, but it is also a continued growth from its own previous growth rate for 2021!
This means that we can expect positive sentiment and significant growth for the United Kingdom over he next two years. We have divergence.
This is very supportive of our Bullish bias for the British Pound and our bearish trade on the EURGBP pair.
Trade Analysis (Imports & Exports) - Neutral
Brent Crude Oil Vs EURUSD
The UK exports oil and many of their trade partners are from the European continent. As the price of Brent Crude oil appreciates, that represents more demand for British Pounds as importers need to convert their currency in order to buy British imports.
The chart above demonstrates that recently, there has been an inverse correlation between Brent Crude Oil Prices and the EURGBP Pair. With Oil currently trending upward and the EURGBP pair trending downward on weekly charts, we can expect this momentum to continue. All we need to do is ride the wave.
XAUGBP VS EURGBP
The UK is the world's 2nd largest exporter of gold. Germany receives over 20% of those gold exports. There is a positive correlation between EURGBP and the price of Gold priced in British Pounds.
XAUGBP is currently in weekly downtrend but it is currently making a very strong counter trend move to the upside. Historically, the EURGBP pair has followed this trend. This would not be supportive of our trade idea.
However, gold is approaching a level of resistance. If gold resumes its downtrend, we would have further support for our trade.
Summary- With Brent Crude Oil's current price action supporting our trade and Gold's price action not being supportive of our trade, our Trade Analysis has yielded a neutral result. However, With gold approaching resistance and being in an overall downtrend, we may get support for our directional bias.
Interest Rate Differentials
Our Interest Rate Differentials indicator shows that the European Central Bank has maintained a 0% interest rate since 2016 following a series dovish moves in an effort to recover from the European Sovereign Debt Crisis. After being hit with the pandemic, the ECB will not be any closer to hawkish stances any time soon.
However, The UK maintains a low but positive interest rate at 0.10%. With a 2% inflation target and current inflation rate at 1.5%, the UK is still 50 basis points away from its target. But with a very successful vaccination campaign creating a safe environment for the UK population to open its economy, could we possibly see Hawkish positioning in the future?
All of this is supportive of our bearish positioning on EURGBP.
Domestic Stock Analysis
UK- FTSE 100
The UK stock market is down from its high's but it is still making higher lows. The uptrend is maintained. This is supportive for our Bullish outlook for the UK Economy and the British Pound.
However, simultaneously we are seeing all time high's on the European Stock market as well.
European Stock Index
But if we compare the price of EURGBP to the value of the European Stock Index we will see an interesting inverse correlation. This means that the European Market may not have been gaining value, but rather that the currency is losing value and so the stock market goes up in dollar terms.
And of course for thoroughness' sake, we examine the UK stock market along with the EURGBP currency pair to see if there is any relationship. We see that as the FTSE100 goes up, the EURGBP has been going down.
Once all trends continue as they are, our domestic stock analysis supports our bearish bias on the EURGBP pair.
Hedge Fund Positioning
Hedge funds have remained Net Neutral on the Euro for some time now. However, we can see a decrease in their Net long positioning on the British Pound. Could this be repositioning, month-end flows?
As it stands now, Net positioning supports our trade idea despite last week's reduction in long positioning. However, we will need to keep an eye on the data for next week for further support for our trade. Any weakness seen in their positioning on the Euro will also be supportive of the trade idea.
On the monthly chart, we are seeing that price has come down from highs dating all the way back to 2008. Historically speaking, we are at the upper end of how high EURGBP has been historically. There is a a lot of room on the downside from a longer time horizon perspective.
However, we are also sitting at a monthly support level as well.
On the weekly chart, we can see that maybe price has already bounced as much as it could from that monthly area of support. Price seems to have hit an overhead area of support turned resistance on the weekly chart and has already begun resuming its previous trend to the downside.
On the daily chart price is showing very little upward momentum and support as it drifts back down to the monthly level completing its bounce.
If price breaks the monthly support level and retests it as resistance, it would be a great opportunity to start accumulating positions. More aggressive traders can begin accumulating positions as price breaks or develops any downside momentum. The weekly support level will be the first target.
Once fundamental data remains unchanged, if price breaks past target one after a bounce, there is sufficient room on the downside for an even longer term position.
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This article is not investment or trading advice. Please seek guidance from a professional who considers your personal circumstances.