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The Pound-to-Dollar Week Ahead: Breaking Higher on Charts and Eyeing December Peaks

- GBP on cusp of breakout after overcoming downtrend on charts.

- Friday's close above 1.2986 opens the door to 1.3285 and above.

- But coronavirus risk aversion may weigh on GBP ahead of budget.

- As quarantine threatens the Italian economy, incites market sell-off.

- USD driven by risk appetite, other currencies in quiet week for data.

- After Fed rate cut obliterates yield advantage and wounds the USD.

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- GBP/USD Spot rate: 1.3045, up +1.81% last week

- Indicative bank rates for transfers: 1.2668-1.2759

- Transfer specialist indicative rates: 1.2829-1.2907 >> Get your quote now

The Pound-to-Dollar rate is on cusp of an upside breakout on the charts after overcoming a key resistance level on Friday, which could ultimately see the exchange rate retest its December highs over the coming weeks.

Pound Sterling underperformed all major rivals other than the Dollar and commodity currencies last week as investors dumped risk assets after the new coronavirus reached more than 90 countries and appeared to spread with increased momentum in Europe. However, the Pound-to-Dollar rose nearly 2% after the Federal Reserve (Fed) obliterated the Dollar's yield advantage over other currencies with an unshedule 50 basis point interest rate cut. 

Dollar weakness enabled Sterling to creep back above the 1.2986 level that represents a downward sloping trendline drawn from December's peak and multiple technical analysts have said that a close above that level would clear the path back toward earlier highs. The Dollar ended last week lower against all major currency rivals other than the Canadian Dollar as appetite for the U.S. currency almost vanished in the wake of the Fed's Tuesday rate cut. 

"Cable has risen to its highest point in over two weeks as it firmly moves away from its early-week (apparent) consolidation band and crossed above its 50 and 100DMA through today’s session (1.3016 and 1.2992, respectively) which is setting up the currency for a breakout after a (somewhat choppy) falling wedge from its Dec 12 high. The pound’s performance for the week has also formed a bullish engulfing candle," says Juan Manuel Herrera, a strategist at Scotiabank

Above: Pound-to-Dollar rate shown at 4-hour intervals.

Pound Sterling had been on the back foot against the Dollar heading into last week as concerns about the prospect of something like a 'no deal' Brexit from the transition period and increased coronavirus-related risk aversion among investors encouraged heavy selling of the British currency. But after finding support at the 50% fibonacci retracement of the summer-to-December uptrend, the Pound-to-Dollar rate has corrected higher.

"The outlook stays negative while capped by the 55 day moving average at 1.3005 and the short term downtrend at 1.2986," says Karen Jones, head of techincal analysis for currencies, commodities and bonds at Commerzbank in a Friday morning research note. "Only a close above the short term downtrend and 55 day ma would be enough to trigger recovery to initially 1.3285 and the 2015-2020 resistance line at 1.3391."

Jones says a daily close above the 1.2986 downtrend means that 1.3285 and 1.3391 are now viable targets, although she has a neutral outlook for the Pound-to-Dollar rate over the coming days and weeks. She's also warned that a daily close below 1.27 would put a return to the 1.2194 back on the table. 

"Prices are extending gains on the break of 1.2850/1.2900 resistance. This suggests we maybe now moving back into the previous upper range under 1.3500 resistance. 1.2890-1.2850 is now pivotal support in the near-term, while 1.3050-1.3100 is next within the range we are monitoring," says Robin Wilkin, a cross asset strategist at Lloyds Commercial Banking. 

Above: Pound-to-Dollar rate shown at daily intervals. Bouncing off Fibonacci support and overcoming downtrend. 

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The Pound: What to Watch 

The Pound underperformed all major rivals other than the U.S. Dollar and the commodity currencies last week and it might remain a laggard over the coming days given the large scale quarantine now in force in Italy, although Wednesday’s budget poses upside risks to Sterling.

Pound Sterling will spend the early part of the week preoccupied by the quarantine of an estimated 17 million people in the Lombardy region of Italy, which was announced by Prime Minister Giuseppe Conte in the early hours of Sunday morning.  Around 14 provinces that are home to almost a quarter of the Italian population went into ‘lockdown’ Sunday and will remain subject to legal restrictions on the movement of people until at least April 03.

An emergency decree signed into law at the weekend requires that no citizens be able to enter or leave the affected areas and nor will they be able to move around inside the areas except for under certain circumstances. The government had already isolated some towns and villages in an effort to control a coronavirus epidemic that was unearthed a fortnight ago, although the weekend’s decree marks a significant expansion of the enforced isolation. 

"Trillions of dollars of market capitalization have been lost in the past couple of weeks. Financial conditions have tightened.  US, UK, and Australian bond yields have never been lower.  The US 30-year bond yield has never been below 2%, and now it is below 1.5%. German Bunds yields are near record lows of near minus 75 bp. Investors seem to be concluding that the Federal Reserve is heading back toward the zero-bound," says Marc Chandler, managing director at Bannockburn Global Forex.

It’s exactly the above kind of containment measure that’s widely believed to have brought China’s economy to a standstill this quarter and it could be the case that Italy, which was already in recession, now faces a similar hit. The news unlikely to be welcomed by the Pound given that Italy is one of the UK’s top ten trading partners, and that’s even before markets get to wondering whether such measures will eventually be seen in other major economies like the UK and the U.S. as both battle their own outbreaks.

The UK government is for the time being dealing with far less than the 5,883 cases that were confirmed in Italy as of Saturday and partly for this reason it’s taken a softer approach to containment than Italy although a weekend of headlines reporting panic buying in the shops suggests members of the public are taking the threat of an outbreak seriously. That could have negative consequences for the economy if it leads consumers to shut themselves away indoors in order to avoid infection.

“The economy started the year on a strong note, but it is only a matter of time before it succumbs to the effects of the coronavirus. To reflect the weaker global backdrop and the likelihood that measures implemented to limit the spread of the virus will dampen business activity and spending by households, we have revised down our GDP growth forecast for this year from 1.0% to 0.7%,” says Paul Dales, chief UK economist at Capital Economics. “We also now expect the Bank of England to cut interest rates from 0.75% to 0.50% soon and the Chancellor to announce in the Budget on 11th March an extra package of measures to help support businesses and households.”

Dales forecasts a 02% increase in UK GDP for the first quarter followed by no growth in the second quarter as the economy suffers from efforts to limit the spread of coronavirus in the UK, which had 205 confirmed cases of it as of Saturday with two deaths. Some major banks sent staff home from the Canary Wharf financial district last week while others have begun to spread key staff out over a number of different offices to minimise the risk to individual teams.

Measures taken in China during the height of its own outbreak turned cities of many millions desolate, exactly the same kind that were expanded in Italy at the weekend, and if replicated across the more than 90 countries battling the virus then the global economy could find itself in serious trouble.

Investors’ nerves have frayed of late  as the disease spread further across the globe including in the U.S. and Europe, leading them to sell stocks and other risk assets en masse. Equity benchmarks are now in correction territory, oil is in a ‘bear market’ and major economy bond yields have hit record lows as investors sought the perceived safety of sovereign debt. And central banks including the Federal Reserve and Bank of Canada have responded with large 50 basis point interest rate cuts, although in the UK attention turns to the government this week. 

“Fiscal policy will likely be the weapon of choice to accommodate the economic impact of the virus through measures such as the deployment of automatic stabilisers, targeted cash transfers (principally in health care) and/or allowing the spreading out over time of tax liabilities (the ‘time to pay’ measure announced this week),” says Abbas Khan, an economist at Barclays. “In the case of a COVID-19 major outbreak, we would expect the government to announce a boost in direct public spending commensurate with the extent of containment measures implemented. Of course, a prolonged pandemic could lead to debt-sustainability issues, if interest rates, already low, do not fall enough to offset a sustained primary budget deficit.”

Wednesday’s budget is the highlight of the week ahead for the Pound as far as the calendar is concerned and investors will be looking to see how the Treasury intends to support the economy as the government grapples with coronavirus. Markets had been briefed to expect a large stimulus in the budget which many had hoped would be enough to avert a Bank of England (BoE) interest rate cut this year after the economy slowed heading into year-end, and expectations relating to this were the main source of support for the Pound in February. 

But the post-election ‘Boris bounce’ in confidence and output is now expected to give way to a virus-induced slowdown and as a result, investors are betting heavily that the BoE announces a rare 50 basis point interest rate cut to 0.25% on March 26. Pricing in the overnight-index-swap market implied on Friday, a 0.32% Bank Rate for March 26, which is close to the 0.25% that would prevail after a 50 basis point cut. 

With the OIS implied Bank Rate at 0.32% the market is already pricing-in a substantial monetary response from the BoE, which might not be fully delivered if Wednesday’s budget does reveal a substantial fiscal stimulus. Incoming BoE Governor Andrew Bailey did say last week that he would like more evidence of a coronavirus impact on the economy before cutting interest rates at all, and if markets come to doubt the likelihood of that large March rate cut then the Pound might find itself back in favour with the market for a time. 

The budget will be delivered in parliament by Chancellor Rishi Sunak at 11:30, just hours after the Office for National Statistics releases UK GDP data for January. Consensus is looking for the economy to have grown 0.2% that month, a slightly slower pace of growth than the abnormally strong 0.3% seen in December. The figures cover activity in the first full month after December’s election and will reveal whether there really was a Boris bounce in the economy after the Conservative Party’s landslide win. 

“We assume that the BoE will look to hold off from an emergency rate cut, favouring a 25bp move at the scheduled meeting on 26 March, in the process leaving additional ammunition,” says Bipan Rai, North American head of FX strategy at CIBC Capital Markets. “The upcoming budget on 11 March will see a nicely timed fiscal boost. Evidence of precautionary measures to alleviate corporate liquidity pressures will likely add to GBP/USD impetus. Look for a close above the 100day MAV at 1.2991 to open the way for gains to extend towards strong resistance at 1.3070.”

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The Dollar: What to Watch

The Dollar was a laggard among major currencies last week after the Federal Reserve took an axe to the Fed Funds rate and many expect it to remain an underperformer now that its interest rate advantage over other currencies has been weakened and the coronavirus is spreading in the U.S.

There is no major economic data due from the U.S. this week so Dollar exchange rates will take cues from the movements of other currencies, changes in risk appetite and developments around the spread of coronavirus in the U.S. This is after the Fed cut its interest rate by 50 basis points to between 1% and 1.25% in an unscheduled decision, significantly reducing the greenback’s yield advantage over other major rivals, which is now weighing on the Dollar.

“The Fed signalled clearly that the door remains open for more easing in the coming months. It has contributed to the sharp fall in US yields to record lows with the 10- year US Treasury bond yield falling to 0.66%,” says Lee Hardman, a currency analyst at MUFG. “With US yields falling faster than overseas, the yield pick-up in holding USD’s is fast diminishing. It makes it harder to justify the USD remaining at such overvalued levels.”

The Dollar could start the week on the back foot against safe-havens like the Japanese Yen, Swiss Franc and possibly even the Euro as investors respond to the Italian government’s emergency decree placing an estimated 17 million people under ‘lockdown’ in the Lombardy regions as it seeks to slow the spread of coronavirus across the country. It instructed at the weekend that nobody be able to enter or leave, or move freely within 14 provinces in Lombardy until at least April 03. 

Italy’s government is effectively taking a quarter of its economy offline in an effort to fight the virus, although the danger for the Dollar, Pound and other currencies is that investors soon begin to ask how long it will be before such measures are contemplated in the U.S., UK and other countries where there are signs of an outbreak. Such questions would likely be unhelpful to both currencies, especially in relation to the Yen, Franc and Euro. 

More than half of all U.S. states have confirmed coronavirus cases, although the national total remained 

“While Treasuries have benefited from safe-haven demand, the main reason why they have rallied is a growing anticipation of significantly looser monetary policy. Investors’ expectations are far from being met, though, despite the Fed delivering an emergency 50bp rate cut earlier this week. Indeed, since that move, investors have revised their expectations for the policy rate down much further and now anticipate that it will fall to near zero within the next year,” says Hubert de Barochez, an economist at Capital Economics. 

The Dollar has gotten the better of only the oil-backed Canadian Dollar and Norwegian Krone since the Fed cut its cash rate last Tuesday, in part because investors see the Fed as likely to deliver further rate cuts in the weeks and months ahead in order to cushion the U.S. economy from the coronavirus fallout. Many analysts say rate cuts will be ineffective in addressing the economic fallout from the virus in the short-term and that fiscal policy, or government spending, is what’s needed. 

And in the week ahead the UK government will set out its 2020 budget which is expected to contain measures aimed at helping companies and households through the coronavirus outbreak as well as spending plans aimed at rejuvenating the regional economies of the north. The Australian government is also expected to do away with its budget surplus target and unveil a “substantial” fiscal stimulus this week too.

Both fiscal policy updates have the capacity to smooth the path ahead for the UK and Australian economies, and might provide support to their respective currencies. And if support is offered to the Pound and Aussie at the same time as the Dollar is in continued retreat from the Yen, Franc and Euro then the week ahead could easily become another punishing one for the greenback. The Dollar index fell -1.9% last week and is now down -0.31% for 2020.

“With the situation very fluid, and with only hints, as yet, of adverse fallout on US activity, we took a first pass this week at re-evaluating US GDP growth in light of the latest news about the likely trajectory of the virus. We now expect Q2 GDP growth to come in at 1.0% q/q saar, down 1.0pp from our view last week,” says Jonathan Millar, an economist at Barclays. “Furthermore, with fallout likely to persist for some time, we expect the level of activity to remain below our previous projection through the remainder of the medium term, with GDP recovering only 0.5pp of this lost growth in Q4 of this year.“ 

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