Fundamental Analysis

GBP/JPY One to Watch amid Market Risks in the Week Ahead

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On Friday, US equity markets stabilized and began to recover from the sharp plunge in stocks a day earlier. Volatility returned to lower levels and Thursday's strong demand for safe-haven assets diminished significantly as of mid-day Friday. Heightened market volatility was initially sparked by widespread worries that the Trump Administration's pro-business agenda would be disrupted by President Trump's recent controversial remarks and his dramatic loss of support from both business and government leaders. These worries were partly ameliorated on Friday after reports that Steve Bannon, one of Trump's top and most divisive advisors, would be dismissed from the team. This increases the chances that Trump's chief economic advisor, Wall Street veteran Gary Cohn, would remain in his position as the most important pro-business voice in the administration.

The rebound for stocks and diminishing volatility on Friday understandably dealt a blow to safe-haven assets like gold and the Japanese yen. In the case of the GBP/JPY currency pair, price initially fell towards its next major target at the 139.00 support level on increased yen demand, but reversed those losses as equity markets rebounded and yen demand weakened on Friday. Though Bannon's dismissal may have given the markets some relief for the time being, support for President Trump from business and government leaders has still been severely damaged, perhaps irreversibly. In addition to these Trump concerns, other geopolitical risks – most notably the North Korean nuclear threat – have not disappeared but have merely faded into the background. Therefore, while market concerns have pulled back on Friday, it is likely just a matter of time before risk worries surrounding current geopolitical conditions rise once again and the yen surges in response.

For GBP/JPY any such yen surge would contribute to an extension of the current breakdown and bearish bias. For its part, the pound has been weakening sharply within the past few weeks, pressured by a dovish-leaning Bank of England during its latest meeting. Next week, amid a relatively light economic calendar, the most important data release for currency markets will likely be the UK's quarterly GDP report, scheduled for release on Thursday.

Amid sustained pressure on sterling, along with the possibility that elevated risk concerns and market volatility return next week, GBP/JPY continues to be biased to the downside after its recent breakdowns. The latest of these breakdowns occurred after a bearish flag pattern, during which the currency pair dropped below both the key 142.00 level as well as its 200-day moving average. Currently, GBP/JPY is targeting the next major downside objective around the key 139.00 level, last hit in mid-June, with a further bearish target around the 137.00 support level.

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