Pound / Dollar Week Ahead Forecast: Recovering 1.36 as Bearish Market Squeezed

• GBP/USD looks for recovery above 1.36
• Supported near 1.3554, 1.3496, 1.3432
• Amid squeeze on GBP/USD short sellers
• UK growth optimism & BoE policy cited
• USD eyes CPI data & GBP looks to GDP

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The Pound to Dollar exchange rate reached two-month highs in the opening week of the new year and could attempt to recover above the nearby 1.36 handle over the coming days as the greenback’s advance slows and the bearish market is squeezed by a recently rejuvenated Sterling.

Pound Sterling was quick off the blocks when rising against all other major currencies last week, taking a tentative lead for the fledgling year of 2022 and coming close to 1.36 against the Dollar for the first time since early days of November.

The U.S. Dollar has meanwhile slowed in its advance against many other major currencies in a possible further sign of fatigue following a strong six-month rally in advance of the now-in-progress normalisation of Federal Reserve (Fed) monetary policy.

That rally and the prospect of rising interest rates at the Fed had contributed significantly to an increasingly bearish stance on Sterling among investors and traders late last year, which saw the market build up a large “short position” and wager against the Pound to Dollar rate.

“Evidence that the surge in Omicron cases may be abating in the UK and speculation that the Bank of England could hike rates again as soon as February appear to be encouraging short-covering activity in GBP,” says Jane Foley, head of FX strategy at Rabobank.

Above: GBP/USD shown at 4-hour intervals with Fibonacci retracements of December rally indicating possible areas of technical support for Sterling.

• GBP/USD reference rates at publication:
  Spot: 1.3583
• High street bank rates (indicative band): 1.3197-1.3292
• Payment specialist rates (indicative band): 1.3450-1.3500
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• Set up an exchange rate alert, here

“A close above the GBP/USD 1.3556 resistance area is likely to energise GBP bulls. We would expect any GBP rallies to peter out during the course of Q1 and would favour selling rallies in anticipation of a move lower for cable on a 3 to 6 month view back towards the 1.30 area,” Foley also wrote in a review of the Pound-Dollar rate outlook last week.

Bets against GBP/USD reached their highest level since the summer of 2020 back in November but punters behind these wagers have been squeezed steadily since the middle of December, prompting a recovery by Sterling that has continued thus far in the new year.

GBP/USD has been aided significantly by the Bank of England (BoE) decision last month to lift Bank Rate back to 0.25% as well as by speculation in interest rate markets that the Monetary Policy Committee could raise the benchmark again as soon as February.

Above: GBP/USD shown at daily intervals with Fibonacci retracements of October’s extended move lower indicating possible areas of resistance to a further recovery by Sterling. Selected major moving-averages denote possible supports and resistances.

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“The pound should find decent support at the 1.35/high-1.34s zone on dips with the mid-figure area following. Resistance after the 100-day MA stands at 1.3577, the 38.2% Fib retracement of its Jun-Dec drop, with the 1.36 level acting as another key mark to beat on the charts,” says Juan Manuel Herrera, a strategist at Scotiabank.

An absence of meaningful restrictions on UK economic activity and social contact may have fueled the market’s bets that interest rates could rise further at the BoE over the coming months, although some economists have cautioned that despite this, the latest derivation of the coronavirus is still likely to have taken a toll on the economy in December and this could mean that Friday’s November GDP data is at risk of going overlooked by the market.

“It shouldn't come as a shock that activity in December and January will be a little more subdued than before. Enforced restrictions via 'Plan B' alongside voluntary social distancing will hit activity – though we only expect this to be modest,” counters Sanjay Raja, an economist at Deutsche Bank.

Above: GBP/USD at weekly intervals with major moving-averages and Fibonacci retracements of 2020 recovery indicating areas of technical support.

Friday’s November’s GDP data is the highlight of the week for Sterling and the consensus among economists is for a strong 0.4% gain, although before then Sterling will have to contend with December inflation figures from the U.S., which could cut either way for the Pound to Dollar rate.

“The first week into 2022 proved to be an eventful one, as Fed minutes and US labor market data prompted sharp market adjustments in an environment where the Omicron variant is driving infection spikes but seemingly with less severe implications than previous waves. With this, all eyes now turn to incoming inflation prints,” says Michael Gapen, chief U.S. economist at Barclays.

“We expect headline CPI in December to rise 0.4% and core inflation to increase 0.5% (0.37% and 0.46% to two decimals, respectively). We forecast energy prices to fall 0.7% m/m - the first decline in six months - on reductions in gasoline, natural gas, and heating oil prices. Food inflation, on the other hand, is likely to remain solid, and we look for a 0.5% rise in December,” Gapen and colleagues wrote in a Friday briefing.

Above: U.S. Dollar Index shown at weekly intervals with Fibonacci retracements of 2020 decline indicating possible technical resistance to a recovery.

U.S. inflation rates have surged to more than six percent in recent months and have, together with a strong and ongoing recovery in the U.S. job market, catalysed an accelerated pivot by the Federal Reserve that has placed the bank on track to lift its interest rate as soon as March this year.

“Investors worried about the lack of ‘narrative impulse’ for long USD views are looking past two very powerful themes that should work in favour of the greenback in H1 2022. First, quantitative tightening (or QT) is very supportive for the USD. Understanding the channel through which the QT theme will work in favour of the USD is important as well. Second, the market is still pricing in too low of a terminal rate for the upcoming rate hike cycle,” says Bipan Rai, North American head of FX strategy at CIBC Capital Markets.

Minutes of December’s meeting showed last week that there was a substantial discussion last month about when and how the Fed should go about shrinking its significantly enlarged $8.8 trillion balance sheet while revealing for the first time that this process known as “quantitative tightening” could begin relatively soon after the first increase in the Fed Funds interest rate.

Source: CIBC Capital Markets.

Many U.S. Dollar exchange rates rose sharply in the wake of last Wednesday’s Fed minutes and illustrated along the way why this Tuesday’s U.S. inflation data will be important for the greenback, in large part because any signs of a further prolonged period of above-target inflation would be likely to solidify market expectations for an imminent increase in U.S. interest rates and commencement of quantitative tightening.

However, CIBC Capital Markets research encapsulated in the above graphs suggests that rising levels of U.S. inflation and other factors that might lift the value of “real yields” and nominal bond yields wouldn’t necessarily prevent the Pound to Dollar rate from edging higher over the coming days.

“Looking ahead, we still think that the QT theme is underpriced and our rates strategists envisage a move in 10-year real yields towards -50bps by the end of Q1. Empirically, we can show that this is supportive for the USD as well – Chart 2 displays the average gain for the USD against the majors, EM and commodity FX bloc whenever real yields are driving nominals in a rising yield environment,” CIBC’s Rai wrote in a research briefing last Friday.