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Crédit Agricole says USD Advance isn't Done

- GBP/USD extends Oct. rally
- Reclaims its 2021 advance
- Aided by improved market sentiment
- Credit Agricole says USD strength unfinished

Dollar outlook

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The Pound to Dollar exchange rate (GBP/USD) extended its October recovery to 1.37 aided by rising stock markets and improved investor sentiment, however a leading foreign exchange analyst says it's too soon to bet against the Dollar.

GBP/USD rallied to 1.37 on October 14, its highest level since September 28 in a move that coincides with a broader rally in global stock markets.

The advance came alongside a move higher in the EUR/USD back above 1.16.

Investor sentiment is turning more optimistic as per the rise in global equity markets, this environment tends to benefit the Pound and disadvantage the Dollar as evident during the decline in global stock markets during the August-late September period.

A further recovery in sentiment could therefore assist Sterling and the Euro higher.

"A more constructive risk tone has weighed on the US dollar, providing support for GBP/USD which has edged up towards 1.37," says Hann-Ju Ho, an economist at Lloyds Bank.

Pound to Dollar four hour chart

Above: Four-hour GBP/USD chart.

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There is little by way of clear catalyst for the improvement in risk, instead the market appears to have made peace with a view that 1) global economic growth rates are likely to be more constrained going forward and 2) the Federal Reserve is set to raise interest rates in the second half of 2022.

"Some positives with respect to the upcoming policy normalisation in the US seem to be in the price of the USD already," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

The general risk tone has also been supported by stabilisation in gas markets.

But, according to Marinov, "the second coming of the USD" is not yet done.

He says the Dollar is benefiting from its status as "the high-yielding, safe-haven king of G10 FX".

The theme "is in full swing and we expect the currency to continue to outperform on the back of widening rate and yield spreads," says Marinov, in a regular currency briefing issued on October 14.

The prospect of higher interest rates in the U.S. - and at other global central banks - is expected to create a tightening in credit conditions that could undermine investor appetite.

"Further helping the USD is the fact that the US seems better insulated than other economies from headwinds related to the global energy crisis and the slowdown in China," says Marinov.

Crédit Agricole note demand for the U.S. currency in the forward markets have been intensifying of late, as reflected in the widening cross-currency basis swap spreads.

These developments reflect a number of drivers says Marinov:

(1) the growing USD rate advantage ahead of Fed taper;
(2) importers’ hedging flows in countries like Japan and the Eurozone that face soaring energy cost
(3) growing demand for USD funding into year-end as international borrowers try to lock in more advantageous conditions when rolling their FX liabilities.

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"Growing demand for USD funding could coincide with falling supply of USD liquidity in the coming months as the FOMC taper and the debt ceiling resolution in December drains excess USD liquidity," says Marinov.

The Pound to Dollar exchange rate's October advance means it is now recording a small 0.25% advance for 2021.

However, the Euro is still down by over 5.0% against the Greenback.