Pound Sterling Drops against Euro and Dollar After Investors Take Fright at U.S. Jobs Data

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The British Pound was amongst the casualties of a global investor shakedown following the release of stronger-than-expected U.S. labour market data and will likely remain under pressure if Friday's jobs report is stronger than the market is expecting.

Stocks, bonds and the Pound fell after ADP reported private payrolls in the U.S. rose by 235K in December which is notably higher than the 152K investors were expecting.

This is just the latest evidence that the U.S. labour market is in robust health and is yet to buckle under the strain of recent U.S. Federal Reserve rate hikes.

In the wake of the data "Sterling underperforms both the dollar and the euro," says analyst Mathias Van der Jeugt at KBC Markets.

The Pound to Euro exchange rate was quoted two-thirds of a percent lower at 1.13 in the wake of the data release and the Pound to Dollar exchange rate was quoted 1.45% lower at 1.1882.

Elsewhere, initial jobless claims came in weaker at 204K against the 230K analysts were looking for, suggesting fewer Americans were seeking out-of-work benefits amidst plentiful employment opportunities.

Further rate hikes will be required if the Fed is to cool the labour market by enough to bring inflation back to its 2.0% target, implying a sharper economic slowdown awaits over coming months.

"Traders have pushed up their expectations for the terminal interest rates in the US. The June Fed funds futures contract implies a peak interest rate of above 5.00% now, much higher than at the start of the week," says Fawad Razaqzada, an analyst at City Index.

Rising expectations for a higher peak in the Federal Reserve's basic interest rate are consistent with higher interest rates across the financial system, a stronger Dollar, weaker global growth prospects and falling stocks.

This deterioration in investor sentiment also impacts the Pound which is highly reliant on inflows of foreign investor capital.

When investors are shy, capital flows away from the Pound.

Above: GBP/USD (top) and GBP/EUR at four-hour intervals. Consider setting a free FX rate alert here to better time your payment requirements.

HSBC research finds EUR/USD and GBP/USD have both been heavily linked to changes in global risk appetite in the last year which explains a loss of value in the two pairs as stocks rode a bear market lower.

New research from HSBC finds suggests global equity market performance will remain a driver for the Pound in the months ahead.

But GBP/EUR is also sensitive to global risk sentiment and tends to undergo weakness during market downturns.

Looking ahead, the Pound's fortunes rest on how much further the stock market decline extends.

Friday brings with it the first U.S. non-farm payrolls report of 2023 and it is clear investors are prepared for a stronger-than-expected reading.

The non-farm payrolls are the definitive labour market data release from the U.S. and should provide a final verdict on recent market developments.

If the figure beats expectations the recent trend higher in the Dollar and fall in the Pound could be reinforced.

"We are particularly focused on the NFP print where we sit appreciably above consensus for a strong number. That may be enough to shift short-term USD dynamics biased to trade on its front foot," says a daily currency research briefing from analysts at TD Securities.

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However, a reading that comes in below expectations could upend the recent market moves and prompt some squaring of Thursday's moves ahead of the weekend as investors assess that recent concerns might be overdone.

The market is currently poised for a reading of 200K jobs, a slowdown on November's 263K.

Investors will also be watching the wage figures as it is wages that really matter when it comes to inflation and therefore the Fed's reaction function.

The following graphic from Forex.com offers a useful rough playbook for how currency markets might respond to the potential outcomes: