Pound-Dollar Rate Nurses Wounds after Federal Reserve Shakes Up Market

- GBP/USD walks wounded near range lows
- Strongest USD rally since Sept follows Fed
- Shakes up a previously one-way FX market
- Job data, CPI targets key drivers up ahead

Above: Fed Chairman Powell delivers a virtual FOMC statement, June 16. Image courtesy of U.S. Federal Reserve. 

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The Pound-to-Dollar exchange rate was walking wounded near the bottom of its recent range Thursday after the Federal Reserve (Fed) triggered a sharp rally by the Dollar when announcing slightly adapted economic forecasts and guidance for monetary policy late on Wednesday.

Sterling had tumbled almost 100 points to just beneath 1.40 against the Dollar by Thursday following overnight losses in which the Dollar Index - a measure of the U.S. currency against its most frequently traded rivals - saw its largest one day gain since September 21 last year.

“A slip below the 2020-2021 uptrend line at 1.3922 (not favoured) would target 1.3575, the 200 day moving average,” says Axel Rudolph, a senior technical analyst at Commerzbank, of GBP/USD.

This was after a majority of Fed policymakers indicated using the ‘dot-plot’ of individual rate setters’ forecasts that they may now be minded to begin lifting U.S. interest rates as soon as the end of 2023 rather than in 2024.

The Fed’s projections indicated that any possible 2023 rate hike could be a larger 0.50% increase to the Federal Funds rate from its currently-unchanged 0.25%-to-0.50% range, rather than a typical 0.25% increase.

Put differently, 10 of the 18 rate setters at the Fed who indicated that they expect the Fed Funds rate range to sit between 0.50% and 0.75% by the end of 2023.

“We remind our readers the FOMC is not a great predictor of the Funds rate,” says Joseph Capurso, a strategist at Commonwealth Bank of Australia.

“The FOMC’s more hawkish rate outlook was supplemented with upgraded economic forecasts. The FOMC forecasts GDP will expand by 7.0% in 2021 (was 6.5%),” Capurso adds.

Above: Pound-to-Dollar rate at hourly intervals alongside U.S. Dollar Index.

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Chairman Jerome Powell did himself remind reporters in a subsequent press conference that the dot-plot is neither an official forecast nor a reliable guide to how the Federal Open Market Committee (FOMC) votes on interest rates.

He emphasised instead that the FOMC is preoccupied with the Fed’s $120bn per month quantitative easing programme (QE) under which it buys $80bn per month of U.S. government bonds and $40bn of residential mortgage-backed bonds.

“While reaching the standard of substantial further progress [toward our maximum employment and price stability goals] is still a ways off, participants expect that progress will continue. In coming meetings the committee will continue to assess progress toward our goals. As we have said, we will provide advance notice before announcing any decision to make changes to our purchases,” Powell told the press conference.

Future changes in that programme are tied to inflation and job market outcomes further down the line and in part because of the unprecedented nature of the coronavirus crisis which has made economic forecasting an especially tough task for policymakers everywhere.

“Taper talk is underway, but Mr. Powell wants to see what happens in the labor market after the summer,” says Ian Shepherdson, chief economist at Pantheon Macroeconomics.

“For someone preaching uncertainty, Mr. Powell is very confident the Fed won't fall behind the curve.”

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Powell also said with frank tone but constructive manner that it’s not possible for the bank to reliably anticipate whether recent strong increases in inflation will be sustained, citing a range of complicating factors including gas or petrol price increases.

This was before later saying the Fed is acting solely in service of its publicly known policy objectives, which are obligations in relation to inflation over the medium-term and employment levels.

The net effect of all of this is that, although the bank has introduced into market discussion the possibility of policy changes that come sooner than was previously guided for, there isn’t really very much about Wednesday’s update that could be written up as meaningfully ‘hawkish’ or in any way indicative of an imminent policy change.

Above: Pound-to-Dollar rate at daily intervals with 100-day average and Fibonacci retracements of key extensions higher.

That in turn implies limited if-any scope for further gains by the Dollar, and likewise with losses for the Pound-to-Dollar rate in the absence of justification by forthcoming economic data emerging from either side of the Atlantic.

“Indicators of longer term inflation expectations have generally reversed the declines seen earlier in the pandemic and have moved into a range that appears broadly consistent with our longer-run inflation goal of 2%. If we saw signs that the path of inflation or longer-term inflation expectations were moving materially and persistently beyond levels consistent with our goal we’d be prepared to adjust the stance of monetary policy,” Powell said.