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Above: Analyst Asmara Jamaleh of Intesa Sanpaolo believes portfolio managers are buying Dollars as they reposition at the start of the new year. Image (C) Pound Sterling Live.

GBP/USD could struggle to advance beyond early Janaury highs amidst signs that downside pressures on the Dollar are waning.

The Pound-to-Dollar rate enjoyed a brief lift higher during morning trading Wednesday, aided by positive economic data from the UK and a rise in government bond yields.

However, the pair could struggle to advance beyond earlier January highs amidst signs that downside pressures on the Dollar might be waning.

The Dollar index fell close to 0.50% during the morning session while Office for National Statistics data showed growth in Britain’s manufacturing sector picking up during the November month.

This helped the Pound-to-Dollar rate to begin charting a northward course but its burst of renewed strength was aided mostly by an increase in the UK's 10 Year government bond yield, which rose by 0.07% to break above 1.29% during the session.

That move was brought about by an auction of £2.5 billion of new government bonds, which drew in a healthy level of interest from investors whose bids saw the government borrow at a rate of around 1.288%

It won’t sound like much but 1.29% is the highest yield for the UK 10 year since the start of December and goes a little way toward reversing a decline that has been all encompassing for the Pound Sterling over recent weeks.

The Pound-to-Dollar rate rose by 0.19% over the course of the morning session, to be quoted at 1.3555, before paring gains to eventually trade at a fractional 0.05% loss.

The greenback is still the worst performing major currency when viewed over the course of the past month, but looking at its performance over the past trading week, it has been among the top three best-performers.

A recent turn in fortune has seen the Dollar make notable headway against the Swiss Franc, against which it has advanced by 1.23%, and the Euro where it has gained 1.11%. Against Sterling it has fallen in value by 0.25%.

"The recovery of the Dollar, still very modest in any case, was probably also supported by the wait-and-see approach generally taken by investors in a portfolio-repositioning phase at the outset of the year, considering that the US currency is at rather weak levels following the sharp depreciation incurred last year, and close to the lows reached in September 2017," says Asmara Jamaleh, an Economist with Intesa Sanpaolo.

Another factor that may have been behind the recent price action for the US Dollar is a rise in US Treasury yields, which jumped to 2.57% on Wednesday, their highest level seen since they topped out back in March 2017.

There are a number of possible reason behind the ongoing shift higher in US yields, including reports that Chinese reserves managers may be considering reducing their purchase, or even holdings, of US debt.

This comes at a time when the Federal Reserve is expected to raise interest rates on a handful of occasions during the year ahead. It will also begin lightening its multi-trillion Dollar balance sheet by ceasing the reinvestment of proceeds from American bonds that it acquired during the quantitative easing years.

The net effect of higher interest rates and lower demand for new US bonds is higher bond yields which, in theory, should be good news for the Dollar.

"Collective wisdom is that this bond sell-off is made in Japan rather than China. More prosaically, it's down to optimism about US growth, concern about inflation ahead of Friday's CPI data, lack of demand ahead of this evening's auction of $20bn in 10year Notes; and (last but definitely not least) concern that global central bond-buying is about to go into reverse," says Kit Juckes, chief foreign exchange strategist at Societe Generale.

"Fed balance-sheet reduction tantrum' isn't nearly as snappy as ‘taper tantrum' but still...."

Incidentally, the double-digit Dollar decline seen in 2017 began to gather pace in March of that year when it became clear to traders that US yields had already seen their best days for the foreseeable future.

For those watching the Pound-to-Dollar exchange rate the subtext is that, in the absence of another Dollar rout or continued increases in UK yields, further strength could be hard to come by. Indeed, a test and break above the January highs just north of 1.36 would be unlikely, particularly in the near-term.

Above: Pound-to-Dollar rate shown at hourly intervals.

“The Pound has led a charmed life and until the issues dogging the USD are more fully understood then this may continue to be the case; but as we see it, a meaningful assault on a tough technical level might be a step too far for a currency increasingly devoid of supportive fundamentals,” says Neil Mellor, a strategist with Bank of New York Mellon.

Indeed, Dollar strength might well be felt across the market place.

"Downside on the Dollar should be waning, save for markedly favourable surprises outside the US – and in particular in the Euro area – or major disappointments in the United States," says Intesa's Jamaleh.

While Jamaleh sees positioning as providing a technical explanation for the Dollar's near-term improvement, others reckon 2018 will see the Dollar make a broad and sustained recovery.

The Dollar struggled in 2017 amidst expectations for unconventional monetary policy to be withdrawn elsewhere in the world, which supported currencies such as the Pound and Euro. Furthermore, economic growth elsewhere - especially in the Eurozone - started to pickup and this helped channel flows out of the Dollar.

But, the Dollar is looking undervalued relative to interest rates, and there are those who believe a correction higher must ultimately occur as this fundamental driver of the currency cannot be ignored indefinitely.

Analysts at Capital Economics believe "some shine could come off other currencies", such as the Euro, if recoveries in the economies where they are issued run out of steam.

"While it may be premature to suggest that this development marks the beginning of a turnaround in the greenback’s fortunes, we suspect that 2018 will be a better year for the currency than 2017," says John Higgins, an analyst with Capital Economics in London. "Overall, we anticipate that both short- and long-term interest rate differentials will help to drive the Dollar higher in 2018."

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