- Long EUR/GBP looks great on the charts, but political risks weigh on the trade
- Going short the pound is much easier, with many catalysts working against the currency
- Short GBP/USD likely to be the safer bet
As EUR/GBP approached its latest bottom close to 0.87, the pair looked fairly oversold using a range of technical indicators including stochastics and oscillators. Since then, the pair has bounced back nicely, rising above 0.88 and making its way towards 0.90. Given strong positive momentum since its latest bottom, the pair looks like an enticing buy when looking at EUR/GBP on a daily chart. This is shown below:
A sustainable EUR/GBP break out?
Euro looking oversold, yet significant risks remain on the horizon
Both the euro and the pound remain highly susceptible to news headlines, and especially with regards to politics. Earlier today, we raised the issue of the independence referendum in Catalonia. While the referendum has had a limited impact on the euro so far, the real risk for the currency remains to be seen. After scenes of violence and protests this past week, political tensions are running high and the likelihood of a negotiated settlement is falling. While the euro is clearly oversold relative to the pound, meaning that EUR/GBP has room to go much higher, going long the pair is a risky trade given the ongoing drama in Catalonia. If the outcome of the referendum in Catalonia takes a turn for the worse, the euro may fall sharply.
Short pound an easier trade
While going long the euro has its risks, the other side of the trade is much easier to manage. The pound is running out of catalysts, with politics, economic data and sentiment weighing against the currency. After last week’s CFTC data was released, speculator sentiment towards the pound seems overly exuberant. In the past few days, economic data (including growth figures released last Friday) have disappointed relative to expectations. This leaves expectations for an interest rate hike “fairly soon” by the Bank of England as the sole catalyst. Given Carney’s reluctance to commit to policy normalization, expectations for monetary policy are likely to be overshadowed by Brexit-related concerns and weak data. Earlier this morning, we downgraded our medium-term outlook on the pound to bearish.
All in all, long EUR/GBP certainly looks like an enticing trade today, but comes with significant risks that are difficult to quantify. Given the limited catalysts behind the pound today, short GBP/USD seems like the better trade to us.