GBP/USD analysis: Cable on verge of big breakout

The GBP/USD was looking strong at the time of writing on Friday, looking to post a weekly close of around 1.5%, supported by stronger UK data and weaker US macro pointers. In the week ahead, we have key UK inflation numbers and global PMI data to trigger the next move. Our GBP/USD analysis remains bullish because of our bearish view on the dollar.

Before discussing the macro factors in greater details, let’s first start by looking at the chart of the cable.

GBP/USD analysis: Key levels to watch

Source: TradingView.com

The GBP/USD was looking for a bullish breakout from a couple of converging trendlines on the long-term charts, and above resistance in the 1.2700 area. Will it be successful? Given the recent moves in other FX pairs, and precious metals, a bullish breakout would not come as major surprise to us, data permitting.

A clean break above 1.2700 could pave the way for a run to the high of 1.2893 hit in March, with the psychologically important 1.300 handle to come into focus thereafter.

On the downside, the high from a couple of weeks ago, which was last week’s point of origin of the breakout, comes in at 1.2595. This level is the most important support to watch on any time frames.

US dollar resumes selling after another short-lived recovery

The GBP/USD turned positive on Friday afternoon along with the other major FX pairs, as the US dollar turned lower. There was also a big breakout in silver prices, with other commodities also rebounding after China unveiled its strongest effort to revive the struggling property market, easing mortgage regulations and encouraging local governments to purchase unsold homes.

Earlier in the day on Friday, FX markets had been far calmer with the dollar extending its recovery that had begun on Thursday. Investors were put off by a quiet day for data, which will remain the case on Monday with most of mainland European markets closed for a holiday.

More on the week ahead below, but let’s first discuss why we have turned bearish on the dollar.

US dollar hit by weak data

We have seen further evidence of an economic slowdown in the US this week. So, it is becoming increasingly difficult to justify maintaining a bullish view on the dollar. On Thursday, jobless claims, industrial production, housing starts and building permits all came in weaker than expected. A day before, CPI missed expectations with a +0.3% m/m reading, and we also saw a flat headline retail sales figure, when a 0.4% increase was expected. What’s more, the Empire State Manufacturing Index painted another gloomy picture for the manufacturing sector, with yet another below-forecast negative reading. Earlier this month, the April non-farm jobs report, the latest ISM surveys and several other pointers, had all disappointed expectations too.

Therefore, it looks like the US economic recovery is slowing, and this will help bring inflation down, reducing the need to keep monetary policy tight for an extended period of time. The Fed’s tapering of its balance sheet runoff has been an additional bearish factor for the dollar.

Looking ahead to the new week and rest of May

We have a few macro events in the week ahead to watch closely if you are trading the GBP/USD, including CPI data from the UK and global PMI data which should be important for the cable. But from the US, there are only a handful of data releases next week to offer direct influence on the greenback, plus some Fed speak. The key US data comes out on the final day of the month when core PCE is released, a week before the May jobs report comes out. Until then, I would expect to see some further dollar selling but at a more gradual pace.

UK CPI is due on Wednesday

UK data have shown surprising strength in the last couple of weeks. Last week saw Average Earnings Index including bonuses come in higher-than-expected at 5.7% in the three months to March compared to a year earlier, adding to the above-forecast 0.6% growth in the first quarter GDP we saw the week before. The UK economy is making strides towards recovery after a dismal couple of years marked by low output and high inflation. With CPI cooling to 3.2% y/y in March, investors have translated the recent data surprises as a goldilocks scenario, sending the UK 100 to repeated all-time highs. If the latest CPI reading on Wednesday now falls more than expected (2.7% forecast) then this could further support UK stocks.

Meanwhile UK retail sales are due out on Friday, which should provide additional direction for the GBP/USD.

Global PMI data

We have seen lots of evidence that the US recovery is starting to fade, just as growth in Europe and elsewhere have started to pick up. Thursday’s release of PMI data from Eurozone and UK’s services and manufacturing sectors will provide us with more insights about the potential recovery in Europe. Are we finally going to see a return to growth of manufacturing PMIs following nearly two years of sub-50 readings for German, French and UK manufacturers? Even if the pace of contraction slows more than expected, this would still be positive news given how poor the sector has performed in recent years.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R