Pound to Dollar: Fed Repricing Maxing Out

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The Dollar's rally is starting to look a little tired, offering Pound Sterling and other currencies the opportunity to retake some recently lost ground in the short term.

The Dollar is broadly softer amidst an improved global investor morale.

"Asian markets were making solid gains across the board on Thursday," says Shane Strowmatt, an analyst at LGT Private Banking. "A sense of calm was returning to markets midweek after several sessions dominated by negative sentiment, which was exacerbated by negative geopolitical headlines out of the Middle East."

Pound-Dollar and equity markets have struggled of late amidst Middle East tensions and as investors cut back expectations for the number of U.S. interest rate hikes in 2024 to just one, having seen as many as seven at the start of the year.

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This suggests the cost of money will remain high for some time to come, slowing global growth and potentially creating risks in the financial system.

But, this repricing in Fed rate expectations might have run its course for now, offering potential short-term comeback opportunities to stocks and the Pound-Dollar rate.

"The market has already gone far in its expectations for key interest rates in the US," says Antje Praefcke, FX Analyst at Commerzbank. The analyst cautions that this is by no means a turning point for markets and she expects further gains for the Dollar, albeit at a more gradual pace than we have seen of late.

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Domestically, the Pound doesn't appear to have received any major lasting boost from this week's stronger-than-expected inflation numbers, confirming the Dollar will remain the primary driving force for the Pound-Dollar exchange rate in the coming days and weeks.

"The path for further US dollar appreciation from here remains clear with the US CPI data forcing markets into a rethink on the starting time for the first rate cut from the Fed. This context and the lack of USD traction prior to the inflation print have resulted in a strong pick-up in positive momentum," says Derek Halpenny, analyst at MUFG Bank Ltd.

This week Federal Reserve Governor Powell responded to those U.S. inflation figures and hinted rates would be kept at current levels for an extended period, saying "the recent data have clearly not given us greater confidence and instead indicate that it is likely to take longer than expected to achieve that confidence".


Above: The market's expected path for Fed rates. As can be seen, far less cuts are now expected than at the start of the year. Image: Goldman Sachs.

Money markets show investors now only anticipate one rate cut in 2024, with a 50/50 chance of a second. This can continue to weigh on broader investor sentiment, particularly if corporate earnings start to stutter.

Economists at Société Générale have updated clients and said they no longer expect the Fed to cut rates in 2024, suggesting the need for further repricing in market expectations. And should the Bank of England cut interest rates as early June, the path to a weaker Pound-Dollar becomes clear.

"GBP/USD could slide to test 1.20," says Kit Juckes, an analyst at Société Générale.

Short-term, the recent Dollar rally will need to unwind, offering some comeback potential. But for now, gains will be viewed as counter-trend and short-lived.