- GBP/USD support at 1.3820, eyes rally to 1.42 & 1.43+.
- Falling bond yields offer balm to bruised global markets.
- GBP rally underwrites EUR, harries risks to BoE’s target.
- Yields, China NPC, UK budget, global factors dominate.
- GBP/USD spot rate at time of writing: 1.3927
- Bank transfer rate (indicative guide): 1.3540-1.3637
- FX specialist providers (indicative guide): 1.3718-1.3830
More information on FX specialist rates here
The Pound-to-Dollar exchange rate went out Friday on its back foot after risk assets hit a global bond market speed bump following an earlier rally that took Sterling to 2018 highs, which will be back in prospect this week as and when the dust settles in international financial markets.
The Pound fell sharply from three-year highs as a bond market bonfire escalated, leading short and long-term borrowing costs into a destabilising rally that prompted a partial reversal of almost all recent exchange rate trends. This was after a weeks-long rout in the U.S. government bond market spilled over into other markets.
Bond market losses and the rise in yields prompted investors to walk away from "carry trade" wagers on emerging market currencies and other assets, which buckled last week and in the process generated automatic Euro and Dollar buybacks after both were used as a "funding currency" in recent months.
“To us, this is just a bull market correction and our upbeat GBP/USD view remains intact. GBP is to benefit from the idiosyncratic vaccine dividend and the less dovish BoE, while the cautious Fed presiding over the deeply negative front-end US real rates should also contribute to higher GBP/USD,” says Petr Krpata, chief EMEA strategist for interest rates and FX at ING. “Overall, the additional fiscal support to be announced next week should underscore the constructive outlook for GBP for 2Q, with the further fiscal help facilitating the economic rebound and making GBP the outperformer in the G10 FX space.”
Above: Sterling Vs the majors over selected timeframes. Source: Netdania Markets. Click for closer inspection.
"The higher US yields have led to tighter global financial conditions, which is far from welcome news in Europe and many emerging markets where vaccinations and the economic outlook lag behind the US," says Erik Nielsen, group chief economist at UniCredit Bank.
The Pound-Dollar rate slipped back below 1.40 on Friday, leaving it third placed behind the Euro and Dollar for the week in terms of performance, although it is well positioned to benefit from any recovery or renewed bid for risk currencies over the coming days.
Domestically the Pound will also turn its attention on Wednesday to Chancellor Rishi Sunak's budget where expectations are for support schemes like furlough to be extended until summer, Speculation suggests tax increases are possible, although it's not obvious that the currency market would object to them.
“This backup in yields is likely a speedbump rather than a roadblock,” says Mark McCormick, global head of FX strategy at TD Securities. “Markets will focus on Chair Powell's remarks on Thursday and top-tier data, including payrolls.”
Above: Pound-to-Dollar rate shown at 4-hour intervals with 10-year U.S. yield (yellow) and 02-year U.S. yields (purple).
Pound Sterling has been at the vanguard of the major currencies in their expression of the reflation trade, thus far in 2021 aided in no small part by the hawkish stance of the Bank of England, which has been made possible by a rapid vaccine rollout that has got economists expecting the UK to top the board of major economies this year.
Coming at a time when many other central banks are marking down their economic outlooks or are simply too busy attemptiong to discourage strength in their currencies, the BoE's stance isn't far off a buy recommendation for Sterling. It's seen the BoE grow more conscious of upside risks to its inflation target and prompted financial markets to begin wondering about the likely timing of its first interest rate rise, however far off, which is supportive of the Pound.
“Further position liquidation in the FX market would provide more support for the USD in the near-term, although we see it as more of a temporary FX market correction,” says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG. “While a deeper correction lower back towards 1.3500-1.3700 can’t be ruled out, the upward trend for cable is likely to resume beyond the position shake out.”
But most important influence on everything short-term is likely the impact of bond market developments. Sterling may be aided later and the Dollar burdened anew if Fed officials on the speaking circuit are able to soothe investors’ nerves. FOMC members Charles Evans, Mary Daly, Lael Brainard and John Williams all have opportunity to offer balm to bruised markets before Chairman Powell’s 17:05 speech on Thursday.
"After volatility recedes in fixed income, we would expect other asset classes to recover, which should push the USD back down toward its cycle lows. This process may take several sessions to completely trickle through," says Stephen Gallo, European head of FX strategy at BMO Capital Markets. "The stabilizing hand of the PBoC has continued to prevent the RMB from declining more abruptly, notwithstanding the general weakness in risk assets."
Source: HSBC Research.
Fed speakers dominate the agenda ahead of Friday’s 13:30 jobs report, although there’s also the prospect of a spillover into Europe from any calming of Asian markets amid China’s National People’s Congress (NPC), which could prompt the Peoples’ Bank of China to restore calm in domestic markets.
"The NPC is the stage on which the government sets out its economic plans. We expect the budget (also on Friday) to confirm the withdrawal of fiscal support," says Sheana Yue at Capital Economics. "The NPC will also be presented with a draft of the new Five-Year Plan."
Pound Sterling Live has its own theory about recent price action in Pound, which would imply that exaggerated bond market moves are to be expected, especially in a reflation minded environment where questions are being asked of policymakers’ commitments to propping up markets.
This is that Sterling is playing an important role in facilitating a Dollar depreciation which results partly from a shift in a certain FX reserve basket,, so was heartened to read in an January note from HSBC last week of the Dollar and EUR/USD’s negative correlations with reserve flows. The Dollar Index and Euro-Dollar are both negatively correlated with the direction of reserve flows, the bank's research shows, and the Dollar Index was up 1.12% for 2021 on Friday while the Euro-Dollar rate was down -1.05%. This is consistent with Pound Sterling Live’s theory which, among other things, assumes GBP/USD needs to rise as far as 1.43 in the coming weeks
"While the USD’s share is now down around 1.1ppt in the last four quarters, the EUR’s share is only up by 0.3ppt,” writes Dominic Bunning, head of European FX research at HSBC, who has a bearish view on both Sterling in 2021.
Above: GBP/EUR at daily intervals with 14-day average & Fibonacci retracements of Jan 2021 rally. GBP/USD in red, EUR/USD in blue with 2-Yr GB bond yield in purple and 2-Yr U.S bond yield in yellow. Click image for closer inspection.