The pound sterling has got into a turbulence zone. Yesterday it went into a nosedive against major currencies, but today it is developing a stunning bullish run. The reason behind such gyrations is Brexit which is driving investors mad. The news creates the opposite market sentiment. Optimism is rapidly replaced with pessimism and vice versa. The British currency is making sharp price swings up and down. After a four-day climb, GBP/USD plummeted by more than 150 pips in just four hours. The sterling was displaying a similar dynamic in cross pairs. Today GBP/USD is following the upward trajectory. The currency pair spiked 100 pips, regaining previous losses. Traders are trying to puzzle out what comes next. To answer this question, let's figure out the reason behind this extreme volatility.
As you know, the UK and the European Union have been discussing the terms of a trade deal for six months (we must exclude the forced "coronavirus pause"). The parties must settle the trade agreement before January 1, 2021. This date is the end of the transition period after Britain leaves the EU. If by this date the negotiators do not come to a consensus and accordingly do not sign any agreement, London will automatically drop out of the single market and will continue to carry out foreign trade with European countries in accordance with the WTO rules. The risk of the so-called "hard scenario" is growing every day, as negotiators cannot reach a compromise on some vital issues. There is very little time left before the New Year, so the parties decided to draw a certain line at the EU summit, which kick off tomorrow. Based on the results of this meeting (which will end on Friday), one of three options will be implemented: 1) politicians in a "closed doors" format will agree on the most difficult issues (after which the negotiators will have to finalize agreements); 2) the participants in the summit will voice their stance but will not come to a common denominator - while the negotiations will continue until the next summit, which will be held in November; 3) the parties will come to the conclusion that no compromise will be reached, after which the policymakers prepare for the UK exit from the EU without a trade deal.
If you look at the daily chart of GBP/USD, you can see that over the past two weeks, all the above-said options have been mirrored in the market one by one. Influential news agencies (such as Reuters or Bloomberg) published insider leaks that were subsequently confirmed or refuted by comments from officials. For example, last week the pound rose in price amid insider reports that German Chancellor Angela Merkel had taken a "conciliatory" stance towards the British, and chief negotiator Michel Barnier has proposed a compromise on fisheries (which is the most difficult to negotiate). However, yesterday, literally 2 days before the start of the summit, pessimistic ideas were voiced. German and French government officials said the negotiations were "in a critical state" and the "hard" scenario was the main option. Boris Johnson, in turn, warned that he would leave the negotiating table if there was no progress. The British reaction was not long in coming: the pound collapsed across the board.
But today the fundamental background has changed again. First, according to Bloomberg, the British side is actually ready to continue negotiations after the October summit. Secondly, the parties have reached "some progress" in the negotiations today, according to Reuters sources. Third, according to the British press, London may eventually compromise on fisheries.
As you can see, today's growth of the British currency rests only on unconfirmed rumors. This suggests that traders tend to believe in a positive outcome of the negotiating saga. Nevertheless, it is obvious that this saga will not end this month. In my opinion, following the results of the October summit, the parties will outline the "red lines" of acceptable compromises and extend the negotiation period for another month. Such a result will support the British currency, especially given the previous pessimism on the part of the Germans and the French.
To sum up, traders speculating on GBP/USD are likely to stick to the principle "the lack is a bad result means a good result." With this rule in view, GBP/USD buyers will be able to hit a fresh high of the week and also test the nearest resistance level of 1.3130 that is the upper border of the Kumo cloud. As for a short-term strategy, it is risky to open any deals on GBP/USD right now amid erratic intraday price moves. If we consider a medium-term strategy, long deals are preferable from my viewpoint. The first upward target is seen at 1.3130, the next one is 1.3200.
