EUR/GBP Short: Back Up The Truck

Includes: FXA, FXB, FXE, FXF, UDN, UUP
by: Ron Finberg

At SwiftTick, we've pretty much been perma-bears on the EURGBP for the past year. Other than a few times where we thought there were some short term technical or fundamental reasons to be long, we have seen the EURGBP as a long term short to put away and hold. Most recently we were advocating taking a shortafter the EURUSD fell and held below 1.3000 last week. The core philosophy behind being short the EURGBP, is it is a way to trade the euro's weakness, without being tangled with dollar risk in case the Fed decided to get involved some way or another and the EURUSD goes skyrocketing.

Even after falling to a low of 0.7954 on Tuesday (its lowest levels since late 2008) the pair could see further downside momentum. Other than the obvious euro weakness, which has underpinned the EURGBP's descent, the pair appears to be also benefiting from fresh demand for the Pound as a result of safe haven buying. In the past, euro holders basically looked towards the Swiss franc or Gold when diversifying out of the euro. However, with the EURCHF being a "dead in the water" trade recently, and Gold falling on slower Chinese demand worries, Forex investors have begun to look elsewhere. Even the Japanese yen has seen a drop of safe haven interest following its February to mid-March plunge. As such, the current environment has led to the Pound being brought up as a possible destination for risk adverse traders.

The arrival of new demand for the Pound has been apparent in charts of the GBPUSD. After breaking out of its multi-month 1.56 to 1.60 trading range, the pair went on to hit 1.6300. Since then, it has fallen back towards 1.6000, on the overall month long dollar rally. However, unlike the EURUSD, NZDUSD and AUDUSD, the GBPUSD's drop has been more gradual, with Forex traders stepping up to buy on the dips and supporting the pair at key levels. Most importantly, this constant flow of Pound demand has come at a time when overall UK economic figures haven't been too exciting; thus showing that traders are willing to look beyond the present, and taking the Bank of England's hawkish rhetoric at face value.

Even with Tuesday's market sell-off, the GBPUSD managed to close U.S. trading above 1.6000 support after briefly dropping below that level. During the day we tweeted "prefer to short EURGBP, a GBPUSD hold above 1.60 with the EURUSD falling below 1.28, than we issue a "back up the truck" for the EURGBP." The basic idea being that if the GBPUSD would find buyers to support its 1.6000 level, it would be another proof that the Pound is seeing steady demand flows, which would keep the EURGBP downside momentum going. That being said, with Pound support holding, we prefer to continue being short the EURGBP and are targeting a move to 0.7850.

Looking ahead, beyond 0.7850, further downside will probably be based on statements from the Bank of England whether they actually are putting monetary stimulus on hold, even with U.K. inflation levels dropping again. What would be very interesting to see is what would happen if the BoE actually starts raising rates towards the end of the year and the ECB lowers rates. If we get to a situation where being short the EURGBP will also produce positive yield, than we could see a "EURCHF" style drop in the EURGBP where it goes parabolic to the downside.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Currently Short the EURGBP from 0.8040