Pound / Dollar Rate Forecast to Struggle as Fed’s Hawks Look to Take Flight

The US dollar could be in for a decent mid-year period as sentiment amongst US Federal Reserve appears to be heading in a pro-USD direction. 

• GBP/USD forecast to remain under pressure over coming weeks
• Some argue not enought USD strength seen to suggest sustained, longer-term uptrend is ready to extend

Above: Boston Federal Reserve President Rosengren this week delivered a strong pro-hike message on US interest rates, supporting dollar sentiment. Pic: Joanne DeCaro, image cropped from original.

While the threat of a notable Brexit-inspired decline in the British pound has receded over recent weeks we find it hard to get bullish on the currency ahead of the EU vote mid-year.

It remains hard to see any sustained buying interest in the UK currency and we would expect any gains to be technical in nature, rather than a reflection of underlying fundamental strength in the economy.

The GBP side of the GBP/USD equation therefore looks to be in the passenger seat over coming weeks.

It is left to the US dollar to set the tone. The USD has struggled in 2016 but the recovery seen this May has seen the GBP/USD come off its April highs.

Is the dollar rally restarting? The dollar exchange rate complex has rallied for the second straight week in a row with the dollar advancing against its G10 rivals in the week ending May 13th.

We have had some interesting debate on whether the USD bull trend is restarting come through this week - for instance UniCredit Bank believe that peak dollar has passed while Deutsche Bank say that is an incorrect assumption.

History would have to side with Deutsche Bank if we consider previous cycles of dollar strength:

For the chart to prove correct though we would however require some fundamental justification for the move, and the responsibility for providing the impetus invariably falls on the decision-makers at the US Federal Reserve.

Much of the May recovery rally in the USD can be explained through the observation that market odds of a June Fed hike rose to 6%, with 53% odds of a hike by the end of the year.

Improving the odds has been the resilient character of the US jobs market, and a succession of Federal Reserve members who continue to warn markets that an interest rate rise is coming.

The most recent Fed voter comments are explicit on the matter:

• Mester: "I support a gradual adjustment of short-term interest rates toward a more normal level, but I view the current level as too low for today's economic conditions. The economy is at or near full employment and inflation is close to the FOMC's target of 2%, yet short-term interest rates remain near historic lows."
• Rosengren: “The market remains too pessimistic about the fundamental strength of the US economy, and the likelihood of removing monetary accommodation is higher than is currently priced into financial markets based on current data.”
• George: “Moving rates to a more normal level and at a gradual pace is necessary to minimise distortions in the economy that can build over many years when rates are held so low.”
• Market odds of a June Fed hike rose to 6%, with 53% odds of a hike by the end of the year.

The most surprising statements came from Eric Rosengren, the Boston Fed President, who is regarded as a “dove”.

He said that the market underestimated the likelihood of a further reduction of the degree of monetary policy expansion.

He also stated that he was worried about the possible negative consequences of interest rates kept too low for too long.

Latest Pound / US Dollar Exchange Rates

	Live: 1.335▲ + 0.18% 12 Month Best: 1.3789
*Your Bank's Retail Rate	1.2896 - 1.295
**Independent Specialist	1.3163 - 1.3217 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

These are bullish comments for the dollar as it implies markets may be caught surprise on their sanguine expectations. If the markets are to ‘catch up’ they will have to push future US yields higher and buy the dollar.

While the shift in tone is by no means bullish enough to warrant fresh multi-year highs in the US dollar exchange rate complex, it does suggest that coming weeks could well go the way of the USD.

“We believe that markets are too negative about rate prospects further out and that the central scenario for the US economic outlook warrants more tightening this year, though with scope to proceed cautiously,” says Hann-Ju Ho at Lloyds Commercial Banking.

Pound to Remain Under Pressure Against the Dollar

With expectations growing that a more active US Federal Reserve is likely over coming weeks and months, we would expect the pound to come under pressure over the near-term.

“The recent consolidation over the 1.4375/65 support region looks to be a classic “flag” type process and keeps us biased to the downside. We target a move back towards the 1.4150 channel support region, with intra-day resistance lying at 1.4465 and then 1.4525/30,” says Robin Wilkins, Ho's colleague at Lloyds Commercial Bank.

Medium-term Wilkins does say he still believe the market should remain in a range around 1.42, with 1.4050/1.3980 support ahead of the 1.35 key lows and 1.48-1.4950 the main resistance levels above this week’s spike highs.

A move up through 1.50 is needed to confirm the 30-year support in the 1.40-1.35 has again held and a gradual move back towards 1.60/1.65 will be seen in the long-term.