On Thursday, the GBP/USD currency pair experienced a significant decline of over 150 points from the day's opening level. At first glance, the pound's sudden drop may appear puzzling, as it seemed unrelated to the ECB meeting. However, there's more to it than meets the eye. Euro and pound are closely linked currencies that usually move in pair. Therefore, when one currency undergoes substantial growth or decline, it influences the other. This was precisely the case yesterday. Despite the Bank of England's meeting being scheduled for the next week, with a 100% probability of announcing further tightening and the likelihood of additional increases beyond July, the market was already prepared to sell the pound, given the ECB's signal of nearing the end of its rate increase cycle.
It is worth mentioning that the Bank of England is also approaching its peak interest rate value. Currently standing at 5%, it may rise to 5.25% next week. Regardless of the inflation levels, the British regulator can only sustain for a while raising interest rates. The rate increases have already exceeded expectations, and we initially anticipated a less aggressive approach. Considering the pound's surge of nearly 3000 points in the past ten months, paired with continuous rate hikes by the Federal Reserve during the same period, the pound is overvalued, and the market has had ample time to factor in all potential BOE tightening. As a result, the pound is expected to decline inevitably.
Of course, the market might experience a counterintuitive and illogical upward trend. It's important to remember that currency market transactions are not solely driven by profit-seeking motives, i.e., based on fundamentals and macroeconomics. Major players in the market may require specific currencies for operational purposes or reserves, leading to occasional movements that have no direct correlation with the nature of reports or events. However, attempting to predict such market actions is futile; hence, conclusions are drawn based on technicals, macroeconomics, and fundamentals.
The US economy exhibited stronger growth than anticipated in the second quarter.
Besides the ECB meeting, two reports were released in the US yesterday. Honestly, GDP reports rarely trigger market reactions, but yesterday proved to be an exception, resulting in high volatility for both currency pairs. The GDP grew by 2.4% in the second quarter, surpassing the forecast of 1.8%. This is the third consecutive instance where actual values have significantly exceeded predictions for this indicator. Despite expectations of a recession, it has yet to materialize. While the market foresees a slowdown in economic growth, it continues to rise as before. This could be a reason behind the dollar's struggles in the past year.
The market lacks faith in the American economy, is deeply concerned about the US national debt, and criticizes the Federal Reserve's actions concerning dollar issuance. Nonetheless, the US economic situation seems positive. Unemployment is low and relatively stable, the job market is active, inflation has dropped to 3%, and the Federal Reserve faces no issues in raising rates. As mentioned earlier, the current macroeconomic backdrop of the UK and the US does not align with the positions of the pound and the dollar with each other.
The second report focused on durable goods orders, and it brought a surprise to the market. The number of orders increased by 4.7%, exceeding the forecast of +1.0% m/m by 4.7 times. Such a significant deviation from the forecast can and should be considered "resonant," clearly favoring the dollar. As a result, the euro had reasons for a sharp decline, dragging the overbought pound down. The market aligned its trading behavior with the fundamental and macroeconomic background for the first time.
The average volatility of the GBP/USD pair over the last five trading days is 114 pips, which is considered "high" for the pound/dollar pair. Therefore, on Friday, July 28, we expect movement between 1.2673 and 1.2901. A reversal of the Heiken Ashi indicator upwards will indicate a new wave of upward correction.
Nearest support levels:
S1 - 1.2756
S2 - 1.2695
S3 - 1.2634
Nearest resistance levels:
R1 - 1.2817
R2 - 1.2878
R3 - 1.2939
Trading Recommendations:
The GBP/USD pair has returned below the moving average in the 4-hour timeframe. It is advisable to maintain short positions with targets at 1.2695 and 1.2673, and these positions should remain open until the Heiken Ashi indicator shows an upward reversal. If the price is above the moving average line, long positions with targets at 1.2939 and 1.3000 might be worth considering.
Explanation of the illustrations:
- Linear regression channels: They assist in determining the current trend. If both channels are aligned in the same direction, it indicates a strong trend.
- Moving average line (settings 20,0, smoothed): It determines the short-term trend and guides the trading direction.
- Murray levels: These are target levels for movements and corrections.
- Volatility levels (red lines) represent the likely price range within which the pair is expected to trade in the next 24 hours based on current volatility indicators.
- CCI indicator: Its entry into the oversold area (below -250) or the overbought area (above +250) signals an approaching trend reversal in the opposite direction.
