Risk Sentiment Rebound Helps Pound Sterling Appreciate against Euro & Dollar

- Cheery investors help GBP higher
- Delta jitters pose key near-term risk
- Economists remain of the view weakness is temporary
- Watch Fed's Jackson Hole event at end of week

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Gains for major stock markets signalled a return of confidence to the global investor community, creating the backdrop for a rally in the value of the British Pound against currencies such as the Dollar, Euro, Franc and Yen.

Stock markets recovered some of the previous week's losses, creating what is typically described as a 'risk on' environment that tends to favour Sterling against the so-called 'safe haven' currencies mentioned above.

However, the flip side of the same coin revealed losses against the 'high beta', commodity and Emerging Market currencies, notably the Krone, Rand, Australian, New Zealand and Canadian Dollars.

"Global stock markets now look to have turned a corner from last week’s sell-off," says Thomas Mathews, Markets Economist at Capital Economics. "While considerable uncertainty about the ultimate impact of the delta variant remains, we doubt it will hold back continued economic recoveries in most developed markets."

The foreign exchange market is currently in the grip of a binary interplay between positive and negative investor sentiment, often referred to as risk-on/risk-off, or simply as RORO.

How the Pound behaves against its major peers over the coming week therefore depends on global influences, particularly because the data calendar in the UK is light and of little consequence.

For those looking for an appreciation in Sterling this is potentially a welcome situation given the recent slowdown in UK economic growth, an outcome that risks lumbering the UK currency with disappointing data releases.

The slowdown was made clear in Monday's release of PMI data for August that came in well below analyst expectations. "The economic recovery might be slowing a bit faster than we had thought, posing a downside risk to our view that the economy will return to its pre-pandemic size by October," says Mathews.

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Driving the dominant RORO trade are the twin concerns of a looming withdrawal of cheap liquidity from the U.S. Federal Reserve and the spread of the Delta variant in Asia which has slowed growth in the region, particularly in China.

China reported the first day of zero new Covid cases stemming from community transmission on Monday, an outcome that perhaps encouraged a more upbeat mood amongst investors.

But it is the issue of the Federal Reserve's decision to withdraw monetary stimulus, known as the 'taper', which will be of particular focus this week.

Thursday sees the delivery of a speech by Federal Reserve Chair Jerome Powell as part of the Jackson Hole central banking symposium and there is a chance he could announce the Fed stands ready to start reducing stimulus, potentially as soon as September.

This would be a positive outcome for the Dollar but a negative one for stock markets that have been stimulated by cheap Fed funding; given the RORO dynamic it would also be a negative for those aforementioned Sterling exchange rates.

But whether Powell even touches on the matter of withdrawing stimulus is debatable, with some commentators pointing out the Fed has been trying to separate Jackson Hole from monetary policy guidance for some years now.

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Above: The S&P 500 - a preferred proxy for investor sentiment - shows bouts of doubt tend to be short-lived in the current market regime.

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Analysts are meanwhile of the view that the Dollar could come under pressure were the Fed to suggest the planned taper might be delayed owing to concerns over rising Covid cases in the U.S.

"Technically, the dollar looks toppy and a correction for the DXY back below 93.0 could follow if Powell remains vague on timing and the modalities of tapering," says Kenneth Broux, Senior Strategist at Société Générale.

The Pound-to-Dollar exchange rate would be expected to recover some recently lost ground under such a scenario, but soo too would the Pound-to-Euro exchange rate which tends to rise when investor sentiment is optimistic.

"Another strong earnings season has provided the foundation for gains throughout the year, and has meant that even small dips like last week are seen as buying opportunities. If there is any nervousness about this week’s Jackson Hole symposium it certainly isn’t showing," says Chris Beauchamp, Chief Market Analyst at IG.