GBP/USD - Yield differential says rally unjustified but risk reversals rise, eyes PMI

• GBP/USD rally to 9-1/2 week high lacks the support of yield differential.
• Options market shows the demand for the GBP calls is on the rise.

GBP/USD moved above 1.35 yesterday and clocked a high 9-1/2 week high of 1.3550 in Asia, but the 10-year US-UK yield differential says the rally is unjustified.  

Yield differential

The spread or the difference between the 10-year US Treasury yield and the 10-year UK gilt yield continues to trade in the sideways manner in the range of 103 basis points and 110 basis points. Moreover, a sharp drop in the yield differential (decline in the GBP positive manner) would have added credence to this month's 500-pip rally.

Clearly, sentiments (Brexit optimism) are overpowering fundamentals (stagnant yield spread) and the options data indicate the divergence could widen further.

One-month 25 delta risk reversal

• The one-month 25 delta risk reversal improved to -0.25 yesterday; the highest level since Oct. 3. It indicates rising demand for the GBP calls.

Looking ahead - UK manufacturing PMI and US ISM manufacturing PMI could influence the exchange rate. Also, Brexit optimism could continue to cap the downside of the pair.

GBP/USD Technical Levels

FXStreet Chief Analyst Valeria Bednarik writes, "technically, the 4 hours chart shows that the upward potential remains strong, as despite the latest pullback the pair remains well above a bullish 20 SMA, while technical indicators barely lost their strength upward, holding at overbought readings. The pair set a two-year high last September at 1.3653, a possible bullish target for the current upward movement, particularly if the advance extends beyond the mentioned daily high and macroeconomic data comes in-line with the trend."

Support levels: 1.3410 1.3380 1.3340  

Resistance levels: 1.3450 1.3490 1.3535