Dollar Fades vs. Pound as Questions Over Federal Reserve Leadership Stall Rally

The US Dollar has recoverered from its 1.3658 highs to the mid 1.32s over the past three weeks, but the recovery now looks like it may be running out of steam; we review the key drivers of this pair, both fundamental and technical.

Speculation about who will be the next Chair of the Federal Reserve once Janet Yellen retires appears to be driving sentiment in the Dollar which has been one of the best performing major currency on global markets over the course of the past month.

The next Chair of the Fed will be incredibly important as they will likely determine the pace of future interest rate rises - any increase in the pace of rate rises would be all-out bullish for the Dollar.

"Tuesday’s pause in the USD rally appears to be taking a more decisive turn and the USD is under broad pressure into Wednesday’s NA open as market participants consider President Trump’s short-list of Fed Chair candidates including Yellen, Cohn, Warsh, and Powell," says Eric Theoret, FX Strategist with Scotiabank in Toronto.

First the Fed chair story played bullish for the currency on the proposal of a hawkish candidate - Kevin Warsh - then it turned bearish after a more dovish candidate was suggested - Jerome Powell.

"Powell is currently on the Board of Governors and is rumored to be favored by Treasury," says Theoret.

This probably explains, in fundamental terms, why GBP/USD's short-term downtrend has suddenly stalled in the mid-1.32s after a 200 point steep drop.

If deciding Janet Yellen's replacement seems trivial it may be because the bigger themes have been done to death.

Technicals Key to Developments in GBP/USD

"Treasury yields have ticked lower and the Dollar is off its recent highs as the market just reins in a touch. This is a near term correction for the Dollar (for now), and with Non-Farm Payrolls just a couple of days away, the move is likely to be short-lived," says Richard Perry, analyst with Hantec Markets.

A combination of a resolutely hawkish Fed and a revival of Trump's tax reforms were the initial twin boosters which began the Dollar's renaissance, but according to Perry these themes are spent:

"The market has all but priced in the next Fed rate hike for December. So the upside potential for this seems to be a little limited. The steam from the initial proposals from Donald Trump’s tax plan has gone out of the market (for now)," says Perry.

With fundamentals fading the technical picture could be more important at this juncture, and the purely technical explanation for the strong support in the mid-1.32s appears to be that it is the location of both the August highs (1.3265) and the 50.0% Fibonacci retracement of the previous (September mainly) rally (1.3247). 

Named after a 13th century mathematician, Fibonacci retracements occur at 38.2%, 50.0% and 61.8% corrections from previous moves and are said to possess powers of support and resistance such that when prices encounter them mid-trend they often stall, pull-back, reverse or consolidate.

The 50.0% Fibonacci level could be critical, according to BNY Mellon's Senior Currency Strategist, Neil Mellor:

"The technical backdrop for GBP could be pivotal: a close below the 50% Fibonacci retracement from the August low to the September high, at 1.3213, would be a positive first step if cable's downside is to be more assured."

In a report yesterday we noted how Trade With Precision's, trading instructor, Hao Sun, earmarked the GBP/USD as a shorting (selling) opportunity, with a downside target at between 1.30-31.

This seems to suggest that the down-trend could extend lower eventually despite the resilience of the mid-1.32s.

Sun, however, wants to see the pair recover to a better position before shorting it, preferring to see it rise to a 'perfect' sell zone in the 1.3350s before opening a short trade.

According to analysis from Commerzbank's, FX analyst, Karen Jones the trendline at 1.3228 is a key watershed for the pair.

If the pair breaks below the 1.3228 uptrend (line), that would be the tipping point for Jones, and "enough to negate upside efforts and signal another leg lower to the 1.2888 2016-2017 uptrend," says the Commerzbank analyst.

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