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Since June, it appears that the GBPUSD is carving out a rare diamond top.  A diamond top is the combination of expanding and contracting price action.  With this in mind, expect more consolidation as the month progresses.  The diamond pattern projects a downside break (eventually), so one may look to short rallies. 

The British Pound/US Dollar currency pair has ostensibly tracked changes in interest rate expectations with noteworthy accuracy through recent months, and the recent improvement in US Federal Reserve rate expectations bodes poorly for the GBPUSD. In fact, Overnight Index Swaps show expectations of 109 basis points in Fed rate hikes through the coming 12 months—narrowly beating Bank of England forecasts at 93. Such developments give us somewhat of a bearish bias on the GBPUSD, but it will be critical to watch upcoming US Employment data to gauge whether the US Dollar can continue higher through the foreseeable future.

The US Dollar has clearly benefited from a relatively bullish string of economic data, and upcoming US Nonfarm Payrolls results are expected to show that the domestic did not lose jobs through the month of December. A disappointment could likely derail the uptrend in US Federal Reserve rate expectations.

The British Pound is only slightly overvalued at this point, trading just 4.3% above its PPP-implied exchange rate. While sterling followed the other majors lower against the Dollar in December, its decline (in percentage terms) fell towards the middle of the spectrum and so momentum considerations do not scream for outsized losses from here compared to other majors. A previously close correlation to yield expectations seems to have faded, with US Dollar sentiment seen as the most significant driver of GBPUSD price action. All told, though the overall bias remains bearish, the narrow value gap does not seem attractive enough to establish new positions for the time being.

What is Purchasing Power Parity?
   
One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.