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A setback for the AI trade has pulled US yields and the dollar lower, with sterling's own outperformance lifting the pair through resistance.
The Pound to Dollar exchange rate has recovered from the low 1.32s to 1.3310 in a two-day rally, lifting it above its 21-day moving average and the 1.3302 resistance line that capped it through October.
The pound is outperforming the majority of G10 currencies this week, with Bank of England Governor Andrew Bailey's remarks in Bangkok giving a boost: he said that the UK's neutral interest rate has risen, raising odds of a November hike and reinforcing the yield support behind sterling.
The dollar side of the move came from a selloff in AI-linked stocks, which overrode the week's hot U.S. inflation data in the space of a session.
Above: GBP/USD at daily intervals, above the 21-day moving average and 1.3302.
The mechanism runs through the bond market: investors selling technology stocks bought Treasuries for safety, pulling yields down and stripping the dollar of its interest rate advantage.
"The US 2-year Treasury yield fell sharply to the 4.7% level as the technology-led equity selloff drove demand for safety, reversing all the initial post-CPI rise in rates," says MUFG in its Asia FX Daily.
The 10-year yield has dropped from 5.32% to around 5.05%, and MUFG says concerns about the tech selloff continued to outweigh the inflation surprise even after a hot producer price print on Thursday.
"Put differently, stocks rule the bond market roost," says Kenneth Broux, Head of Corporate Research FX and Rates at Societe Generale.
Broux says haven flows from profit-taking in U.S. tech stocks, the most overexposed long position since 2020 according to Bank of America's fund manager survey, are compressing the yield spread between Treasuries and other G10 bonds.
Core U.S. inflation beat expectations on Wednesday and producer prices rose 1.3% on the month on Thursday, the fastest in over four years, and the dollar has fallen through both.
International Investors Cut Dollar Exposure
Foreign ownership of U.S. technology stocks is the reason this risk-off episode weakens the dollar where past episodes strengthened it.
"When they cut their risk exposure at times of market distress especially one that is centred on US technology stocks, they also cut their USD exposure, thus eroding its appeal as a safe-haven," says Credit Agricole in its FX Weekly.
The bank is reworking its "dollar smile" framework into a "smirk" to reflect the dollar's reduced haven appeal, given the growing reliance on risk-correlated foreign capital.
OCBC describes the same effect from the Asian side, where record foreign equity outflows hit Taiwan this week.
"For FX, this creates an unusual combination: risk-off, lower Treasury yields and a softer USD," says OCBC in its daily outlook.
OCBC says the AI boom has become a pillar of U.S. growth and a structural support for the dollar, and the more the dollar benefits on the way up, the more exposed it becomes if that support fades.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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"The USD remains the biggest long in the G10 FX at present and saw some buying interest last week, predominantly driven by IMM flows," says Credit Agricole.
Dollar longs stood at $35bn ahead of the inflation data, the highest since August, and the Pound was the biggest short in G10, according to Credit Agricole's positioning model.
A crowded dollar long meeting a crowded sterling short is the setup that turns a yield move into a half-cent jump, and Credit Agricole has a tactical long GBP/USD from 1.3246 targeting 1.3776.
Fed Chair Kevin Warsh gave no rate guidance at his Bangkok appearance alongside Bailey, cutting October hike pricing and adding to the dollar's slide, says Kristina Clifton, Senior Economist at Commonwealth Bank of Australia.
On the pound's side, Thursday's GDP data showed the economy growing at 2.1% year-on-year, which Broux says adds to the case for a November Bank of England hike.
Credit Agricole judges Bank of England pricing too aggressive and forecasts the Pound to Dollar rate at 1.31 in three months, so the durability of the rally rests on the dollar side.
Our house view is that the pound stays capped into the 28 October Budget and recovers afterwards, and this week's move brings the recovery forward.
The RSI at 50.5 shows momentum has turned neutral from oversold, and a daily close above 1.3302 opens the way to 1.3506.
The dollar's direction now follows the Nasdaq, which Societe Generale says needs to hold its 50-day average at 26,500 to avoid a deeper decline that would extend the pound's recovery.
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 specialist
