"Dollar Should be Higher" says ING as Pound to Dollar Exchange Rate Defends 1.25

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The Dollar should be stronger following Thursday's strong U.S. data, warn analysts at ING Bank, expecting a delayed USD rally.

The Pound to Dollar exchange rate fell sharply after U.S. consumer spending showed the persistence of hot inflation trends in the U.S. economy, but it recovered to go back above 1.25 ahead of the weekend.

But ING analyst Francesco Pesole says the Dollar's weakness is out of kilter with equity and fixed-income markets, and he doesn't expect it to last long.

"We expect a delayed USD strengthening after yesterday’s upside surprise in 1Q US PCE data," he says.

The Dollar rallied after the core PCE price deflator - a measure of consumer spending - came in at 3.7% q/q annualised, three ticks above expectations.

Services spending came in at a 4.0% annualised growth rate, which makes for the fastest surge in consumer services spending since the stimulus-fueled binge in 2021.

This is not the kind of data the Federal Reserve would like to see following a rapid cycle of interest rate hikes, and it has led markets to bet the first interest rate cut will now only come in December.

"The dollar should be trading higher," says Pesole. "The very short-lived USD jump against major currencies denotes how the FX market still has some tendency to give greater weight to negative news on U.S. data compared to USD-positive news. But a lagged re-linking with higher rates and lower equities looks likely."

ING tells clients that the main drivers of FX all point to a stronger dollar: higher Treasury yields, widening swap differentials in favour of the dollar, and falling equities.

"It would not be the first time that the dollar reconnects with rates and equities with a small lag. We think this is likely to happen today or early next week," says Pesole.

If this assessment is correct, the Pound-Dollar exchange rate will be on course for another foray below 1.25 before long.