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Abstract: Hedge funds are beginning to wonder whether the GBP's rally could last longer after it unexpectedly became the best-performing currency in the Group of Ten this year.

Fundamentals

Average wages in Britain slowed again in April after an unexpected surge in March. As the Bank of England (BOE) has given much attention to this and the next CPI data, the likelihood of a pause in interest rate increases at the June meeting is slightly higher. The short-term drop in GBP prices reflects this.

The UK inflation data to be released on May 24 will play a decisive role in the BOE's next interest rate decision, thus affecting the direction of the GBP. If inflation starts to drop sharply from now on, as expected by the BOE, it may not raise interest rates further, which will put pressure on GBP.

However, the risk that the BOE will take more action has certainly increased since last week. The BOE raised its key interest rate by 25 basis points to 4.5% and said its next decision on June 22 would depend on the data.

We believe that the BOE is expected to continue to raise interest rates as inflation in the UK exceeds that in the U.S. and the eurozone. The policy of raising interest rates may initially attract earnings-seeking capital, but it also increases the likelihood of a recession, with any sharp downturn in the economy likely to cause investors to sell GBP. The impact of the tightening cycle will be much greater in the UK than in Europe or the U.S., where people save less and have more mortgages. Therefore, interest rate hike is terribly negative for the economy.

Hedge funds are currently bearish on the GBP at their highest level since December 2021, due to worries about the UK recession.

After more than three consecutive weeks of going long, leveraged investors turned to hold the contracts of 6,858 net GBP short positions in the week ended May 9, according to the Commodity Futures Trading Commission (CFTC).

Meanwhile, the International Monetary Fund had previously warned that the UK was the only G7 country likely to experience a recession this year. There is growing concern that the fight against inflation will come at the expense of the economy.

The GBP has performed well before, so profit-taking is also attractive. Goldman Sachs and Jefferies LLC's bullish bets could be threatened if the GBP weakens.

Technical Analysis

The GBPUSD quickly regained ground in the early European session after the temporary negative impact of higher unemployment and jobless claims and wage levels, as widespread expectations (the BOE will raise interest rates again in June) continued to support the GBP.

The new rally, if sustained, will produce an initial signal that a sharp correction from the peak of 1.2679 will be rolled out. However, this requires the closing price to be higher than 1.2562 to lay the foundation for further recovery.

However, the prolonged decline in the New York session has once again frustrated hopes of an upward pullback in prices. This means that it will take longer to pull back the price.

On the other hand, considering the downward momentum of MACD and the negative slope of RSI, the short-term risk tends to be downward rather than upward. Nevertheless, the GBPUSD was well supported near the upward trend line drawn from last September's record low of 1.2445.

On a bullish note, the price closed above the 20-day SMA of 1.2520 and the focus will again fall near the key long-term downtrend of 1.2635. If the cap is breached, bulls will push prices above a one-year high of 1.2679 again.

Overall, the GBPUSD seems to be preparing for a new bearish trend after another rejection near the long-term resistance trend line. However, unless prices fall below the upward trend line of 1.2445 and the 50-day SMA, the GBPUSD may have another chance to rebound. It is recommended to buy the dips.

Trading Recommendations

Trading direction: Long

Entry price: 1.2470

Target price: 1.2680

Stop loss: 1.2345

Deadline: 2022-05-30 23:55:00

Support: 1.2518, 1.2472, 1.2444, 1.2402

Resistance: 1.2562, 1.2590, 1.2624, 1.2640