The Pound-Dollar Rate Week Ahead: Upside Bias Intact but Iran Fracas Dominates

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- GBP pares gains amid spike in geopolitical tensions.

- Charts suggest GBP/USD remains bid above 1.2908.

- But U.S.-Iran tensions set to dominate FX this week.

- Geopolitical tensions favour USD, other safe-havens.

- Brexit bill could clear parliamentary hurdle this week.

- U.S. nonfarm payrolls and ISM survey also in focus. 

The Pound-to-Dollar rate found support on the charts late Friday after receiving a drubbing early in the New Year, although technical analysts at Commerzbank say retains an upside bias and that a retest of its 2019 election highs cannot be ruled out for the days and weeks ahead.

Sterling was on the back foot from moment one in the New Year following strong gains earlier in the week, although the initial move lower came without any obvious catalyst. And the downward correction was egged on Friday by an increase in risk-aversion across markets amid a spike in tensions between the U.S. and Iran, which favoured the Dollar and Yen in the world of FX.

The Pound-to-Dollar rate still closed the week a fraction higher against the greenback after arresting losses just above 1.3050 mid-way through the Friday session. Risk currencies had rallied into the New Year as investors celebrate President Donald Trump's claim that his 'phase one deal' with China will signed on January 15, with Sterling's outsized gains possibly owing themselves to the extent of the post-election correction that carried it into the holiday week.

However, investors will wake Monday to reports of more hawkish U.S. rhetoric toward Iran that could again prove supportive of the Dollar and a headwind for the Pound. Nonetheless, Commerzbank says the exchange rate should retain an upside bias so long as the market remains above 1.2908.

Above: Pound-to-Dollar rate shown at daily intervals. 

"We look for dips lower to remain well supported by the 55 day ma at 1.2980. The low on the 23rd December was 1.2908 and while above here we will assume an upside bias to retest the December high at 1.3515. The December high at 1.3515 guards the September 2017 high and 38.2% retracement (of the move down from 2014) at 1.3658/68. This guards the more important 1.3918 2007 -2020 downtrend," says Karen Jones, head of technical analysis at Commerzbank.

Jones has been betting against the Pound-to-Dollar rate since it last traded at 1.3208 although she told clients to begin exiting the position when the market was at 1.31 and to close the trade completely when the 1.3025 level is reached, suggesting she doubts the exchange rate will see prices far below that threshold. She says Sterling will continue to eye a fresh challenge of the 1.3515 December election-induced high over the next one-to-three weeks. 

"Sterling is a bit weaker on the change of focus as safe haven seeking is at odds with recent popular long sterling trades like GBPUSD," says John Hardy, head of FX strategy at Saxo Bank. "1.3000 is an important technical and psychological level for cable."

Above: Pound-to-Dollar rate shown at weekly intervals. 

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Pound Sterling: What to Watch

Pound Sterling softened against both the Euro and Dollar heading into the weekend as investors responded to an admission by President Donald Trump that U.S. forces were responsible for the killing of a senior Iranian military commander in Iraq, stoking tensions between the two rivals that are likely to again set the agenda in currency markets early in the new week.

Tensions were already rising between the U.S. and Iran after the White House said the U.S. was responsible for an earlier missile attack on an Iran-backed militant group in Iraq, although the death of targeting of General Qassem Soleimani earlier in the week has exacerbated the fued. And now hawkish White House rhetoric could see risk assets remain on the back foot Monday and safe-havens continue to outperform.

In that environment the now-slow-moving domestic story could easily fall by the wayside for Sterling.

Monday sees the IHS Markit final services PMI for December released at 09:30 and consensus is for the earlier ‘flash’ estimate of 49.0 to be revised higher to 49.1, although risk might be to the downside given that both the construction and manufacturing surveys have already surprised on the downside despite markets also looking for upward revisions there too.

"Figures covering the pre-election period are affected by high political uncertainty, so the poor PMIs for December shouldn’t cause too much concern," says Andrew Wishart at Capital Economics. "The first “clean” data for the post-election period. It is in these we need to see some improvement in order to confirm a “Boris bounce”. If that doesn’t happen, expect interest rates to be cut in the following months."

Tuesday sees the Withdrawal Agreement Bill back before parliament for the ‘committee stage’ before the whole of House, which could take until the end of Wednesday, while Lords amendments and the Third Reading of the bill are expected to take place Thursday. The bill is the legislative vehicle through which the withdrawal agreement is brought into force.

Prime Minister Boris Johnson’s withdrawal bill is widely expected to become law given the scale of the Conservative majority so the event itself is seen by analysts as unlikely to move the Pound, which will leave Sterling to take its cues from developments in the international arena and on the charts.

That being said, Johnson will meet European Commission chief Ursula Von der Leyen in Downing Street on Wednesday as markets wait to hear if a possible February visit to the U.S. and meeting with President Donald Trump will be confirmed. Senior Tories have been calling for the government to waste no time in starting parallel trade negotiations with the U.S. and Foreign Secretary Dominic Raab is set to meet Secretary of State Mike Pompeo in London Thursday, although that meeting may now be overshadowed by the State Department’s ire over the UK’s response to recent events in Iraq, which has echoed that of France and Germany.

"Three and a half years after the EU membership referendum, the UK will finally leave the EU in 4 weeks’ time," says Jane Foely, head of FX strategy at Rabobank. "The tone and the pace of the talks between the UK and the EU will be instrumental for guiding GBP in the months ahead and we see ample scope for GBP/USD to dip back to the 1.28 area as politicians on both sides lay out their positions. If an appropriate deal is successfully negotiated it is possible that GBP/USD could trade in a 1.35-1.40 range in 2021. That said, there is a lot of ground to be covered before this becomes a realistic prospect."

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The Dollar: What to Watch

The Dollar received a drubbing in the dying days of 2019 as investors celebrated U.S. claims that a 'phase one deal' with China will be signed mid-month although it was saved from further losses early in the New Year by a sharp rise in tensions with Iran, which look set to offer further support to the greenback in the days ahead. 

President Donald Trump said on New Year's Eve that he will be signing his phase one deal with China in the White House of January 15 before visiting Beijing shortly after to begin phase two of the negotiations, which will be more ambitious than the last. The deal will see some of the tariffs imposed on exports either side in the last year reduced and will prevent further hostilities so long as its terms are adhered to and talks continue between the two sides.

The announcement is a win for the troubled global economy and so encoraged an immediate bid from investors for so-called risk assets although the positive moods is being increasingly undermined by tensions between the U.S. and Iran, which have risen since the White House claimed responsibility for a missile attack on an Iran-backed militant group in Iraq that led to protests outside of the embassy in Baghdad and culminated in the U.S. killing of Iran's General Qassem Soleimani on Thursday. 

"Both US Treasuries and the dollar have started the year on the front foot as the escalation of tensions between the US and Iran has prompted renewed safe-haven demand. While we think that Treasury yields are unlikely to move much in 2020, we expect the dollar to continue to recover from its autumn slump," says Jonas Goltermann at Capital Economics. 

President Trump may now have upped the stakes again when saying via his Twitter feed late Saturday the U.S. has preselected 52 sites inside Iran for attack in the event that any of its bases or personnel in Iraq or elsewhere are targeted by the Gulf state's forces. Investors are unlikely to welcome the hawkish White House rhetoric, which could see risk assets remain on the back foot Monday and safe-havens continue to outperform.

Capital Economics says a war between the U.S. and Iran would shave 0.5% off global GDP due to a likely collapse of Iran's economy and the impact of higher oil prices on inflation and real GDP growth. That prospect could keep stock markets under pressure and the Dollar supported on Monday although economic data will also be a key focus of the Dollar in the week ahead too. 

“The greenback remains a well-functioning safe haven for global investors when geopolitical risks are involved. When the bombs fall, investors push into the dollar,” says Ulrich Leuchtmann, head of FX strategy at Commerzbank. “It is therefore not surprising that, in light of the news of US air strikes on Iran, the Dollar Index (DXY) is rising and marching towards 97.00 again, and that EUR-USD is relinquishing most of its gains from the end of 2019.”

The Dollar's gains moderated late Friday when the Institute for Supply Management (ISM) manufacturing PMI fell to its lowest level since the financial crisis for December, even though markets were looking for a modest gain in the index. So the greenback could suffer again on Tuesday of the ISM's sister survey of the much larger services sector also follows suit at 15:00 Tuesday. Consensus is looking for the latter to rise from 53.9 to 54.5 for December. 

December's nonfarm payrolls report will also garner a lot of attention at 13:30 Friday, although more so if it manages to disappoint economist expectations. Consensus is looking for the economy to have created just 150k new jobs last month after producing a 266k increase in November, while the unemployment rate is seen holding steady at a multi-decade low of 3.5% and average hourly earnings growth is seen rising from 0.2% to 0.3%. 

"All roads lead to non-farm payrolls Friday," says Andrew Grantham at CIBC Capital Markets. "After such a huge gain in the prior month, it makes sense to expect a deceleration in December. Provided the slowdown isn’t too severe (i.e. payrolls growth is still above 100K) market reaction shouldn’t be that big."

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