Trade of the Week: GBPUSD ready to rock

In recent sessions, GBPUSD has been relatively quiet, trading just below a key resistance level.

But such relative calm could be pierced this week as markets pit the policy signals out of two major central banks against each other:

the US Federal Reserve (a.k.a. the Fed) vs. the Bank of England (BOE).

First, a quick refresher on how FX markets tend to react to central bank policy moves.

Generally, the central bank that can keep raising its interest rates further while its economy can withstand those higher rates (relative to another central bank's benchmark rates/economy) typically sees its currency strengthen.

READ MORE: (September 2022) Why FX markets react to central banks

And on that premise, GBPUSD has climbed by more than 2.5% so far this year.

The price consolidation seen in the above chart also suggests this FX pair’s next move may be a big one, depending on how the Fed and the BOE act over the coming days.

According to Bloomberg’s FX forecast model, there’s a 72% chance that GBPUSD trades within the 1.2182 – 1.2614 range this week.

Whether this FX pair (nicknamed "cable) goes up or down is likely to depend on which central bank can convince markets that it’s got more rate hikes in store for 2023.

What are markets expecting the Fed and the BOE to do?

Overall, the BOE is expected to hike by a larger amount compared to the Fed:

• This week: BOE to hike by 50bps vs. the Fed’s forecasted 25bps hike
   
• This year: BOE expected to hike by 100bps in total (including this week’s expected hikes), compared to the Fed’s forecasted remaining hikes of 50bps

Depending on how much either central bank deviates from the above-listed scenario, that may well determine the size of GBPUSD’s move this week.

Overall, if the BOE confirms this week that it can officially out-hike the Fed, not just this week but also over the coming months, that could trigger the next leg up for GBPUSD.

However, we could be in for a SURPRISE this week, if the:

• BOE hints that it’s almost done with its own rate hikes, for fear of incurring too much damage to the UK economy.
   
• Fed reiterates its intentions to keep sending US interest rates higher than the 5% peak that markets are forecasting.
  
  After all, Fed Chair Jerome Powell has often said he wants today’s Fed to avoid the mistakes from the 1970s, when the then-Fed eased up on its rate hikes too soon.

The above scenario (dovish BOE + still-hawkish Fed) may then trigger GBPUSD into unwinding some of its recent gains.

Key levels for GBPUSD:

RESISTANCE

• 1.24511: this marks the 61.8% Fibonacci retracement level from GBPUSD’s 2022 peak-to-trough action.
  
  Although Pound bulls were fought back at this level in mid-December, they are biding their time once more and consolidating just below this key technical level, awaiting hawkish cues from the BOE to help GBPUSD breach this initial resistance level.
   
• 1.265: this area resisted GBPUSD upside at both ends of May 2022, and may do so again in the near future.

SUPPORT

• Upper 1.22 region: cycle highs from early August 2022
   
• 1.218: around where GBPUSD’s 50-daysimple moving average (SMA) currently lies.

At the time of writing, from current levels just below 1.24, Bloomberg’s FX model is pointing to a slightly likelier chance that GBPUSD would dip below 1.22 (16.5% chance) rather than breach the 1.26 mark (15% chance).

Amid rising expectations for heightened immediate volatility for GBPUSD, it’s increasingly evident that FX markets are on tenterhooks, eager to react to the latest clues out of the Fed and the BOE this week.