Forex Market Analysis

Nov 24, 2022 | Currency Market Analysis

Global Themes

Sterling shines as Fed slowdown boosts sentiment

• Dollar slumps as slower Fed hikes signalled
• Pound receives political boost
• GBP/USD spikes to 3-month high
• GBP/EUR clips €1.1650

Delivered by George Vessey

US dollar

Dollar slumps as slower Fed hikes signalled

The US dollar continued on its downward trajectory against a basket of currencies following a slew of economic data supporting the notion of a US Federal Reserve (Fed) pause in its rate-hike cycle and a potential pivot next year. Minutes from the Fed’s November meeting also saw a “substantial majority” of policymakers in support of slowing down the pace of interest rate rises soon – further weighing on the US currency.

Ahead of the Fed’s meeting minutes, November's flash PMIs were published, with services sector activity at its second-lowest reading since the pandemic began. Meanwhile, weekly jobless claims rose to a 3-month high unexpectedly. These weak data points are a result of the increasing headwinds from surging inflation and higher borrowing costs caused by the Fed’s aggressive rate hike schedule. As such, markets are now pricing the Fed’s funds rate to peak in May next year and then start falling as the US economy tips into a recession. This is why the US dollar is on the backfoot, but the reality is that the Fed believes price pressures are becoming embedded in some areas which means a peak rate above 5% is still possible and interest rates may have to stay elevated for longer than markets are currently pricing.

  • The “risk on” market reaction saw US stocks climb and Treasuries rally, whilst the dollar extended its drop with EUR/USD testing the $1.04 threshold and GBP/USD scoring fresh 3-month highs.

British pound

Pound receives political boost

Despite UK PMI prints yesterday cementing fears of a looming UK recession, the British pound extended higher against most currency peers. The catalysts were improved global risk sentiment following the news from the US, but also a couple of positive political developments for sterling.

The first political boost for the pound was the UK court’s ruling that the Scottish government cannot hold a second referendum on independence next year without approval from the British parliament. If the court ruling had gone the other way, a sharp pound sell-off would have likely ensued. Instead, the removal of this uncertainty likely supported GBP demand. There is also growing optimism that a closer trading relationship between the UK and EU is on the horizon. UK PM Rishi Sunak appears to be taking a softer approach with negotiations related to post-Brexit trade with the EU. According to some independent estimates, Brexit accounts for most of the 25% decline in exports to the bloc last year compared to pre-pandemic levels, so reducing trade frictions with the EU will only be beneficial for the UK economy and thus investor sentiment towards sterling.

  • Exports have declined despite sterling’s depreciation since Brexit. In the five years prior to Brexit, the average GBP/USD rate was $1.58. Since the vote to leave in 2016, the average rate has been $1.31 - a 17% fall. In this new regime of higher interest rates and elevated inflation, and with a global recession pending, can sterling rise towards this post-Brexit average or is a new trading range being established with the low $1.20s now the new ceiling? A short-term bullish scenario is outlined below.

US dollar

GBP/USD spikes to 3-month high

As noted above, the pound climbed against multiple currencies yesterday, but the weaker-than-expected US data combined with the Fed’s minutes last night, also helped GBP/USD defy expectations and rise over 1.5% to reclaim the $1.20 handle for only the second time since August.

Short-term technical analysis suggests more upside for GBP/USD might arise, but in the medium-term, the fundamental economic landscape remains concerning for the UK and therefore the pound. However, a 50% retracement of the 2022 high ($1.3760) to low ($1.0380) swing, has been achieved and the 200-day moving average currently located at $1.22 could be the key level of interest. This moving average often acts as a tough resistance level and has done since September 2021, but it can also act as a springboard if broken convincingly.

  • With US markets shut for Thanksgiving today, perhaps yesterday’s GBP/USD rally was enhanced by a “sterling short squeeze” ahead of the holidays. This is where strong buying pressure “squeezes” traders betting against the pound out of the market, further fuelling a rise in the pound’s value. FX speculators are still net short sterling, so there’s potentially more room for GBP/USD to squeeze higher in the short term.

Euro

GBP/EUR clips €1.1650

The weaker US dollar has allowed EUR/USD to climb back above $1.04, but even so, GBP/EUR tested 3-week peaks yesterday, scaling the €1.1650 area, which is a 61.8% retracement of the 2022 high to low fall of 11.3%.

A sustained rally through winter will likely depend on whether Europe suffers a deeper economic downturn over the winter months. Both Eurozone and UK flash PMI prints remain consistent with a fourth quarter fall in GDP in both regions, but with Europe more exposed to the energy crisis, a colder winter, coupled with reduced gas flows from Russia could weigh heavier on the bloc and be the catalyst for an extended move higher in GBP/EUR.

  • After just closing above its 200-week moving average last week, we noted that an acceleration higher was possible for GBP/EUR. The next upside targets could be the 100-week moving average at €1.1680 and the 50-week moving average at €1.1750.


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