US dollar to stay bullish as the pound falters amid Brexit woes

The US Dollar Index has gained following the midterms while volatility in the pound remains high

If Theresa May cannot get her Brexit deal passed, it could spark a long term bear rally for the pound. Photo: Reuters

The US midterms came and went and, as if we don’t need more volatility and uncertainty, we now have a split in Washington.

For once the projections were accurate with the Democrats taking the House of Representatives while the Republicans took the Senate. This leaves Donald Trump and his future policies precariously placed. Such a situation leaves Washington in political gridlock, which will see it far more difficult for the president to get his agendas passed and this should lead for an interesting end to this year and start of next.

The US Dollar Index has gained following the midterms, albeit amid choppy price action. We saw the index surging towards 97.50 levels before finding support at 96, above which we are seeing good consolidation. I maintain my dollar bullish bias and expect to see consolidation above 97 levels through December.

The US economic calendar is packed over the next two weeks; some of the key releases I am watching out for include the US GDP reading for the third quarter (due out today) expected at 3.5 per cent quarter on quarter. Tomorrow sees the release of the PCE deflator, a measure of the price pressure of goods and services produced and consumed domestically in the US.

Any beat on the year-on-year figure would lend good buying support in US assets in the immediate short-term. This is followed by the US Federal Open Market Committee meeting minutes, due out on Thursday. Keep an eye out for the US nonfarm payrolls report on December 7; expectations are for payrolls to grow above 205,000, with average hourly earnings to grow to 0.3 per cent month-on-month. Again, growth in the weekly earnings will support dollar long positions. And finally, the US data docket is rounded off by the overall inflation print due on December 12.

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With the US midterms out of the way, forex markets turned their attention back towards the UK and EU. Over the weekend, the EU ratified Theresa May’s Brexit proposal and now attention will turn back to the UK as Mrs May embarks on a hectic campaign to raise support for her plan in the lead up to the parliamentary vote which falls in two weeks’ time.

Early voting patterns suggest Mrs May has an ardent task ahead of her as she faces opposition within her own party to get this deal done. At last glance, 409 MPs currently sit against the deal (out of which 90 are from May’s Conservative party) while 230 are in support of her deal. Like all political events these days, this will be hard to predict but one thing is for certain – volatility in pound crosses will remain high during the first two weeks of next month.

Last month, we expected to see a breakdown in GBP/USD towards 1.27 levels (on November 15, the cross sunk as low as 1.2723 on Dubai Gold & Commodities Exchange. The pound has since been consolidating above 1.2780 but has been clearly lacking upward traction.

Ongoing pessimism around Mrs May’s efforts could see a selloff towards the channel between 1.2660/1.2680 with upsides capped at 1.2930 levels. If Mrs May cannot get this deal passed, Brexit negotiations would move back to square one which would spark a longer term bear rally – exposing further downsides in the pound which could see a move towards 1.20 levels against the dollar in a worst case scenario.

With two weeks of trading to go, it would prove ardent to build short positions with small take profits in the lead up to the week of December 10 at which point traders should limit their pound exposures heading into the UK parliamentary vote.

Like the pound, the euro remains under pressure against the Greenback. Following the midterms, the common currency sunk as low as 1.12 levels before rallying to 1.1470. Recent favourable developments of Italy’s concurrence with EU budget rules have kept euro longs interested. However for December, expect the euro to remain under pressure as a result of Brexit. Also, expect to see a weaker EUR/USD, which looks more susceptible to a move towards 1.12 versus a move towards 1.15 in the weeks ahead.

Gaurav Kashyap is a market strategist at Equiti Global Markets. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti