Image © Adobe Images
The Fed's hawkish turn keeps the pound-to-dollar rate under pressure while UK rate hike bets look stretched.
Investment bank analysts say the Federal Reserve's resolve under Chair Kevin Warsh leaves the pound-to-dollar rate exposed to further losses in the near term.
"We see scope for further dollar gains over the near-term," says Lee Hardman, Senior Currency Analyst at MUFG.
What the Fed Delivered
The Fed raised interest rates by 25 basis points to 3.75-4.00% on Wednesday, its first hike since July 2023 and the first under Warsh.
The decision was unanimous with sixteen of the eighteen FOMC members see another hike this year, according to SG.
The first rate cut in the Fed's projections has been pushed out to 2028 and markets assign a probability of just over 50% to a hike at the October meeting, days before the November 03 midterm elections, according to Lloyds.
Daniella Arcadipane, Senior Currency Specialist at Indigo
Moving a life-changing sum abroad? You won’t be doing it alone.
Warsh's Message
"I would be hard-pressed to describe broad financial conditions as restrictive," said Warsh, repeating a phrase from his Jackson Hole address.
The hike "removed a dose of accommodation," he added.
In plain terms, Warsh judges US interest rates to be still too low to restrain the economy, which points to further hikes.
Where the Pound Stands
The Pound has struggled against this backdrop: the pound-to-dollar rate closed Friday at 1.3395, down 1.0% on the week, having touched 1.3336 on Thursday.
The pound-to-euro rate held steady at 1.1661, confirming the week's move was a Dollar story.
Sterling had been under pressure after the Bank of England held Bank Rate at 3.75% a day after the Fed hiked, and overhauled its quantitative tightening programme to reduce sales of long-dated gilts.
"The action was intended to alleviate upward pressure on yields which could weigh on pound performance over the short-term," says Hardman.
Daniella Arcadipane, Senior Currency Specialist at Indigo
Moving a life-changing sum abroad? You won’t be doing it alone.
One specialist explains every step in plain English and stays with it until the money lands. FCA authorised, FRN 594433.
Talk to a specialistThe UK Pricing Problem
Money markets price 39 basis points of Bank of England hikes by December and 96 basis points by July next year, according to DNB Carnegie.
Analysts point to three reasons that pricing could fall:
1. BofA calls market pricing of close to four UK hikes "excessive" and says markets outside the US will have to pare back their rate hike expectations.
2. Governor Andrew Bailey said the MPC did not discuss raising rates four times, as implied by the forward curve, according to SG.
3. BBH says the UK economy is already operating below capacity, Bank Rate sits near the top of the Bank's estimated neutral range, and fiscal policy is likely to turn more restrictive.
"Bottom line: GBP remains vulnerable to a dovish BOE repricing," says Elias Haddad, Global Head of Markets Strategy at BBH, a view that echoes our assessment of the Bank's caution.
BofA adds that "the bar for Warsh to out-hawk the market has become relatively high," leaving UK rate expectations with more room to fall than US ones.
The Case Against a Sustained Dollar Rally
• "Going forward, tightening by other major central banks limits policy divergence with the Fed and suggests USD is unlikely to make new cyclical highs," says Haddad.
• MUFG concedes that front-end rate spreads do not suggest any notable Dollar strength, and has left its longer-dated Dollar forecasts broadly unchanged.
• "Ambitious market pricing, dependence on equity inflows, and debasement concerns argue against sustained strength," says Julius Baer, which maintains a bearish Dollar outlook.
Politics and Oil
• President Trump has called for lower interest rates, and Danske Bank says the unanimous hike underlines the Fed's independence from the White House.
Highly accurate consensus projections for the next four quarters, compiled from leading investment banks.
Access the full forecast →
• Julius Baer says easing concerns about that independence helped the Dollar surge after the decision.
• SG warns the single cut the Fed projects before the end of Trump's term could deepen tensions with the administration.
• The Fed is counting on lower oil prices ahead "from some progress in getting tankers moving through the Straits," says Avery Shenfeld, Chief Economist at CIBC Capital Markets.
• US Central Command said on Saturday that oil and gas shipments through the Strait of Hormuz over the past two weeks reached a six-month high, which would ease pressure for further Fed hikes if sustained.
Pound-to-Dollar Levels to Watch
1. Resistance: 1.3410, according to SG.
2. Thursday's low: 1.3336.
3. Support: 1.3270, according to SG.
Wednesday's flash PMIs are the next test, with BBH expecting the data to confirm the US growth edge over the UK and keep the pound-to-dollar rate pinned below 1.3410 resistance.
