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Pound-to-Dollar: Yields Drive US Dollar Higher As Market Awaits Fed Chair Decision

There are multiple factors that could help sustain the Dollar’s advance on the Pound, including the prospect for markets to revise expectations for UK interest rates lower and US rates higher. 

The Dollar has begun to take back ground against the Pound Tuesday as a steady rise in yields buoys the greenback and markets position for an imminent announcement of President Donald Trump’s preferred candidate to lead the Fed from February 2018.

The Pound-to-Dollar rate slipped 0.12% during early trading Tuesday, to be quoted at 1.3186, after taking its lead from rising US Treasury yields.

There are multiple factors that could help sustain the Dollar’s advance on the Pound over the coming weeks, including the prospect for markets to revise expectations for UK interest rates lower and US rates higher.

“If 10-year Treasury yields can progress beyond 2.4% and into the ample technical space thereafter, then USD bulls may be able to build on the momentum provided by last week’s US budget deal,” says Neil Mellor, chief currency strategist at BNY Mellon.

Treasury yields have trended higher in the US after lawmakers approved a 2018 budget bill that contained instructions to begin reconciling future spending with President Trump’s planned tax cuts.

“We’re assuming that a tax cut bill will be both more modest in scope than what has initially been discussed, and delayed in its impact until 2019,” says Avery Shenfeld, chief economist at CIBC Capital Markets.

Shenfeld notes that Republicans currently favour a revenue neutral tax cut, which means robbing Peter to pay Paul and ensuring that tax cuts don’t exacerbate the budget deficit.

This is the more fiscally responsible option but it also takes some of the bite out of the stimulus tax cuts and reforms are expected to provide.

“A larger, deficit financed tax cut in 2018 would accelerate the need for offsetting monetary policy tightening and would also attract capital inflows to take advantage of lower corporate tax rates,” says Shenfeld. “These impacts would likely see a firmer US$ in 2018 than in our base case.”

Adding fuel to the fire underneath the Dollar is the debate over who will lead the Federal Reserve from February when incumbent Fed Chair Janet Yellen sees her term expire. The field has recently narrowed in favour of three candidates after what was previously a many-horse-race.

Fed governor Jerome Powell and Stanford University economist John Taylor are both strongly in the running. So too is incumbent Janet Yellen after winning praise from President Trump at the weekend.

“Our forecast for a somewhat weaker US$ assumes that new Fed appointees are of a similar philosophy to Yellen,” says Shenfeld.

Both Yellen and Powell are doves who favour lower for longer interest rates while Taylor’s approach toward monetary policy is something that is seen as likely to mean a sharp upward revision in market expectations for the Federal Funds rate.

“From here the relative improvement in our US economic forecasts inclines us to a more favourable tactical view on the dollar,” says Pal Meggyesi, a foreign exchange strategist at JPMorgan.

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