GBP/USD volatility soars as USD short squeeze fuels correction

Volatility is rife for the pound, which in turn has seen the currency trade in a choppy fashion.

The rise in virus cases and subsequent lockdown measures have added to the pound’s woes, not to mention that political uncertainty has been heightened by the ongoing UK-EU trade talks. That said, while idiosyncratic factors have been a key driver for a weaker GBP/USD, there has also been an element of a short squeeze in the US dollar amid the pullback in risk appetite.

Figure 1. Multi year high USD short interest fuels correction

GBP rallies capped until tangible progress is made on Brexit

Despite the recent push back from the Bank of England (BoE) Governor on negative interest rates, GBP/USD struggled to sustain upside, suggesting that the pair remains vulnerable to further losses until tangible progress is made between the UK and European Union (EU) in reaching a Brexit agreement.

That said, with little positives going for the pound as of yet, rallies risk being capped, therefore putting support at $1.2690-$1.2700 into focus, where a break below raises the risk of a 1.26 test. On the topside, initial resistance is seen at $1.2790-$1.2800 and $1.2850.

Figure 2. GBP/USD price chart: daily time frame

IG client sentiment warns of reversal lower

IG client sentiment data shows 48.16% of traders are net long with the ratio of traders short to long at 1.08 to 1.00. The number of traders net long is 15.74% higher than yesterday and 0.45% higher from last week, while the number of traders net short is 2.69% lower than yesterday and 7.94% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net short suggests GBP/USD prices may continue to rise. Yet traders are less net short than yesterday and compared with last week. Recent changes in sentiment warn that the current GBP/USD price trend may soon reverse lower despite the fact traders remain net short.