Pound / Dollar Rate Risks Further Losses as Fed Policy Shift Looms

• GBP/USD nurses wounds near 2021 lows
• Downside risks abound still on Fed policy
• With faster QE taper, early rate rises eyed

Above: File image of Federal Reserve Chairman Jerome Powell. Image © Federal Reserve.

The Pound to Dollar rate (GBP/USD) was nursing wounds near 2021 lows during what is Thursday’s Thanksgiving holiday for the U.S. market although minutes of the latest Federal Reserve (Fed) meeting suggest there remains a risk of it falling further over the coming weeks.

Pound Sterling was treading water against the Dollar when quoted near to its lowest level for the year on Thursday after falling close to the round number of 1.33 in the prior session as investors weighed a seemingly growing risk of a faster pace of monetary policy normalisation from the Fed.

If anything that risk grew with the overnight release of minutes from the Federal Reserve that ended on November 03 after the meeting record revealed that some U.S. policymakers were already considering whether the bank’s quantitative easing programme should be wound down at a faster pace well before November 10 when official figures showed U.S. inflation rising to its highest since 1990.

“In short, then, the hawks appear to be more numerous than the doves,” says Ian Shepherdson, chief economist at Pantheon Macroeconomics.

“The silence of the doves in recent days speaks volumes; they appear to have conceded ground to the hawks and, accordingly, in the light of these minutes and the data which have been released since, we now expect the Fed to announce a faster pace of tapering at the December FOMC meeting, opening the door to a rate hike potentially in June,” Shepherdson wrote in a note following the release.

Above: Selected extracts from minutes of November’s Federal Reserve meeting.

• GBP/USD reference rates at publication:
  Spot: 1.3320
• High street bank rates (indicative band): 1.2955-1.3057
• Payment specialist rates (indicative band): 1.3210-1.3254
• Find out about specialist rates, here
• Or, set up an exchange rate alert, here

“Some participants” thought the Fed should reduce bond purchases carried out as part of its quantitative easing programme at a faster rate than the $15BN per month agreed at that meeting while “various participants” said at the meeting that the Fed should be prepared to quicken its tapering process and begin lifting the Federal Funds interest rate sooner than currently guided for if inflation risks escalate in the months ahead.

“San Francisco Fed President Mary Daly is now the latest FOMC member to throw her weight behind a faster QE taper,” says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG.

“Overall, recent developments suggest that the Fed is likely to speed up the pace of tapering at the December FOMC meeting and open the door to a rate hike potentially as early as in June of next year,” Halpenny said in a research note on Thursday,

The Fed had announced after November’s meeting that the $120BN per month bond buying programme would end by the middle of next year while Chairman Jerome Powell said at the subsequent press conference the bank felt it could afford to wait patiently for recent increases in inflation to fade before beginning to lift its benchmark interest rate.

But inflation figures have continued to surprise on the upside and had already been heavily politicised in the U.S.

Above: Pound-Dollar rate shown at daily intervals.

The official measure of U.S. inflation rose above 6% in October and the accelerating trend was confirmed on Wednesday by the latest reading of the Fed’s favourite measure of inflation pressures, the core personal consumption expenditures price index, which rose from 3.7% to 4.1% for the 12 months to the end of October even after alcohol, food and energy prices were excluded from the data.

“USD strength is currently dominant and GBP seems likely to struggle to regain levels above 1.3350. A retracement (basis Mar 2020 low) around 1.3150-75 appears to be a likely target for further USD strength,” says Tim Riddell, a London-based macro strategist at Westpac.

This acceleration of price pressures is widely perceived as resulting from disruption caused by governmental attempts at containing the coronavirus but it has come amid a continued recovery of the employment market and could be enough to persuade the Fed to go for a sooner reversal of the interest rate cuts it had announced in support of the economy during the early days of the pandemic last year.

“Payrolls and ISM next week likely accentuate the picture of an economy shaking off the delta soft patch, albeit still facing heavy supply chain and reopening headwinds,” says Richard Franulovich, head of FX strategy at Westpac.

“Dollar Index dips have been few and far between, but anything into the low 95s is a clear buying opportunity for a run-up into the 16th Dec FOMC. 98.0 offers some resistance for DXY, but beyond that it’s blue sky into 100,” Franulovich and colleagues said on Thursday.

Above: U.S. Dollar Index and level implied as fair value by U.S. bond yield spreads. Source: Westpac.