The Pound to go Higher Against the Dollar in 2018: Wells Fargo

Wells Fargo analysts are "relatively neutral on the greenback" in the near-term, but expect renewed weakness as 2018 progresses which should allow the Pound-to-Dollar exchange rate to appreciate.

North American banking giant Wells Fargo believe the Pound-to-Dollar exchange rate will likely go higher in 2018 amidst a broad-based decline in the value of the US Dollar and an expected medium-term recovery in Sterling. 

October saw the Dollar strengthen broadly against the G10 basket as Federal Reserve officials took turns signalling to markets the FOMC remains undeterred from raising interest rates further, despite persistent weakness in inflation.

A currency tends to appreciate in value as its central bank raises interest rates - or to be more accurate - a currency appreciates as markets believe interest rates will rise in the future. Rising interest rates at the central bank push up the yield on money market assets, which attacts foreign inflows of capital which in turn bids up the value of the currency. 

“The greenback’s gain extended a period of consolidation, a pause in what had previously been a theme of global monetary policy convergence and trend of U.S. Dollar weakness,” says Nick Bennenbroek, a currency strategist at Wells Fargo.

"Global monetary policy convergence" refers to the current trend of global central banks raising interest rates to push them back to normal levels. Again, raising rates supports their respective currencies, in this case at the expense of the Dollar.

Global economic growth has continued apace, something which ordinarily lends itself to Dollar weakness as other central banks eye an opportunity for them to begin normalising monetary policy.

The Dollar story is however one that extends beyond interest rates - the Trump administration's push to cut taxes and overhaul some parts of the tax code also helped lift the greenback as traders bet on a consequent boost to growth and inflation.

“Markets are focused on likely U.S. rate hikes and tax cuts for now, while after a flurry of central bank activity, the next hawkish global central bank signals may be some time away,” Bennenbroek adds.

This has been good for the Dollar but Bennenbroek believes much of 'the goods news' for the Dollar on this story has been absorbed, raising downside risks in the event of a disappointment.

“We are relatively neutral on the greenback in the near term, but expect renewed weakness as 2018 progresses,” Bennenbroek says, in Wells Fargo’s latest monthly FX outlook.

The Pound Can Go Higher Against the Dollar

“Another currency that may see limited further gains for the time being, and again reflective of a pause along the policy convergence path, is the British pound,” Bennenbroek notes.

The Pound surged throughout September and much of October as markets responded to a hawkish swerve that saw the Bank of England raise its interest rate for the first time in decade come November.

“Speculative British pound positioning swung from a net long of 31,400 contracts in early October to a modest net short of 5,500 contracts by early November,” Bennenbroek adds.

The Bank’s swerve helped to rescue Sterling from renewed Brexit-related weakness but in November policymakers emphasised the gradual nature of any further hikes while removing the language that “monetary policy could need to be tightened by a somewhat greater extent over the forecast period than current market expectations” from their latest statement.

“That is perhaps a further indication that additional U.K. rate hikes may not be forthcoming in the near term, meaning that the Pound’s advance may also be limited for the time being,” says Bennenbroek.

That being said, when the relative narratives around the Dollar and Sterling are squared off against each other, the outlook for the Pound begins to look more bright once into 2018.

“The Pound could see a fairly mixed performance in the near term before resuming its gains against the greenback over time,” says Bennenbroek. “Our medium-term outlook for Pound gains remains intact, particularly once the greenback resumes its downward trend and as further BoE rate hikes come into focus.

Wells Fargo Forecasts

The Pound-to-Dollar exchange rate has risen by close to 7% during the 2017 year to date, despite Sterling’s weakness against other currencies, aided in part by a poor first half for the greenback.

“GBP/USD is consolidating within an overall uptrend. The Relative Strength Index of 46 is fairly neutral, while other momentum indicators are leaning slightly negative,” says Bennenbroek.

Sterling should gain steadily against the Dollar over the next 18 months, according to Wells Fargo forecasts, rising to 1.3200 shortly after year-end and to 1.3600 by the end of 2018.

Separately, Wells Fargo's technical analysts say GBP/USD can be expected to find strong support at the 1.3107 level and if that breaks, below here, in the 1.3000 area.

Resistance is seen at the 1.3321 November high and, above here, at 1.3500 and 1.3657.

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Near-Term Upside Risks Building for the Pound

Sterling has had a good week against the US Dollar having risen 0.45% over the past five days at the time of writing, taking the 2017 advance to 7.44%.

The Pound is a political currency at present; therefore the direction of travel of Brexit talks will matter greatly.

The question markets want answered is whether the UK and EU can agree to move talks onto trade and the future relationship in early 2018 - the tone set a December conference on Brexit held by European leaders will be key in answering this question.

In particular, progress on the question of the amount of money owed by the UK to the EU after Brexit must be made to move talks forward.

"We see increased upside risks for the pound due to clear signs of progress being made toward a financial settlement that could result in transition and trade talks beginning in January. We will get a better sense of any progress that has been made when PM May meets with European Council President Donald Tusk at the EU summit in Sweden later today," says Derek Halpenny at MUFG.

According to Manfred Weber - the head of Europe’s centre-right MEPs in the European Parliament and a close ally of German Chancellor Angela Merkel - UK Prime Minister Theresa May is close to offering a deal on payments that would unlock Brexit negotiations.

Weber said he had received “positive messages” during a meeting in Downing Street mid-week.

Weber told reporters he had witnessed a substantial shift in the British approach which might now allow EU leaders to move on to the next stage of negotiations.

Following a meeting held with Theresa May, David Davis and Amber Rudd, Weber notes:

“I am one of the more sceptical partners from the European parliament side on Brexit negotiations and ongoing progress but I have to say that after my meetings today my main message is that I am more optimistic that there is progress; that there is the will to see progress.

“The message is that the will is there.

“That is the most important thing, because the perspective from a European point of view toward London was that in the last month or two there was not. After my meeting I have more certainty about the general direction and that is positive.”

For a currency that is so closely tied to political gyrations, this development is supportive.

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