Pound-Dollar Rate Underperforms Even as Greenback Doubles Over Ahead of Federal Reserve

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- GBP/USD spot at time of writing: 1.2463
- Bank transfer rates (indicative): 1.2134-1.2221
- FX specialist rates (indicative):  1.2283-1.2358 >> More information

The Pound-Dollar rate underperformed on Wednesday even as the greenback itself doubled over ahead of the release of first-quarter GDP data and the latest Federal Reserve (Fed) policy update, and some analysts tip the exchange rate to remain roadblocked by the 1.25 level for a while to come.

Sterling was wallowing at the bottom of the major currency barrel as a government auction for bonds maturing in 2024 produced healthy levels of demand from the market and the lowest interest rate yet for the five-year segnment of the yield curve. In normal times Sterling can often trade with a positive correlation to bond yields, although this relationship has been known to reverse, as it did in March at the peak of the coronavirus liquidity crisis.

"On an outright basis, the 5yr sector is trading close to its most expensive levels in history. More recently, whilst the yield on the bond has been range-bound over the past 8 sessions, it had richened around 2bps yesterday," says Peter Schaffrik, a global macro strategist at RBC Capital Markets. 

Above: 5-yr GB government yield at daily intervals. Differs from yields achieved by auction participants.

The 5-year auction produced a bid-to-cover ratio  of 2.79 and a yield of just 0.103%, less than half the Bank of England (BoE) base rate of 0.25%, although this might not have been the only factor weighing on Sterling. Brexit is also increasingly expected to return as a headwind in the weeks ahead.

A possible slow-coach exit from 'lockdown' could be an additional burden if Prime Minister Boris Johnson's plan disappoints investors later this week. The UK was the last major European economy to contract the coronavirus and was slow out of the blocks in responding to the threat.

"The upside for sterling from here appears somewhat limited," says George Vessey, UK currency strategist at Western Union Business Solutions. "The $1.25 and €1.15 levels versus the dollar and Euro have acted as key support and resistance levels in the past and yesterday’s trading pattern showed little appetite for GBP buyers to jump in beyond these levels."

The Pound-Dollar rate was again retreating from the 1.25 handle on Wednesday, a level that's blocked its path higher repeatedly in recent weeks, despite the greenback weakening against all other major rivals for the session. The British currency was down against all majors for the session.

Above: Pound-Dollar rate at daily intervals with Fibonacci retracements of 2020 downtrend and moving-averages.

Price action comes ahead of first-quarter U.S. GDP figures and the latest Federal Reserve policy update. Markets are now looking for the Bureau of Economic Analysis to reveal a historic -4% contraction for the quarter, although there are both upside and downside risks to that number which would have consequences for exchange rates. The data comes ahead of Eurozone GDP figures due out on Thursday and will be especially important for price action in the Euro-to-Dollar rate and Dollar Index. 

"Consensus looks for a -4% saar US GDP outcome," says Kit Juckes, chief FX strategist at Societe Generale. "The Eurozone data could be even worse and the US data less bad than that, according to our economics team. I'm wary of the euro under the circumstances. I'd rather buy it at higher levels."

A larger-than-expected contraction cannot be ruled out given the U.S. economy tends to produce its weakest numbers every first quarter, while a better-than-expected number would fuel hopes among investors about the prospect of a quick 'v-shaped' recovery. A worse-than-expected outcome could stoke fears for the global economy and lift the ultimate safe-haven that is the Dollar, weighing further on the Pound-Dollar rate in the process.

However, the full implications might not be understood by the market until after figures are released from the Eurozone on Thursday. Consensus looks for only a -3.7% contraction, a curious expectation given that Italy and others have been battling the coronavirus under lockdown for longer than the U.S. 

Above: Dollar index at daily intervals alongside Euro-to-Dollar rate (blue line).

"The risks are growing that the steps taken could start to weaken the US dollar more notably. We have maintained our bullish view for the dollar based on US equity markets being set for a correction – but the longer US equity markets remain firm, the more the dollar will be vulnerable. The VIX is now at its lowest level since early March," says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG. 

A U.S. economy that underperforms the Eurozone economy in the first-quarter could bearish for the Dollar and bullish for the Euro-to-Dollar rate, although recent history would suggest the risks actually favour U.S. outperformance and possibly a stronger Dollar, although the 19:00 Federal Reserve policy update will have the longer-lived implications for the greenback. 

The Federal Reserve has taken the weight of the world's largest economy on its shoulders this year and pulled out all of the stops to minimise the long-term damage to the most vital cog in the global economic engine although it's actions have produced a radical increase in the supply of Dollars on the market and are expected to weaken the greenback meaningfully once the coronavirus crisis subsides. It's not clear what, if anything the bank will do or say on Wednesday. 

"The improved supply of dollar in tandem with the Fed’s aggressive policy actions on interest rates and on QE have sparked a discussion about whether the USD is now primed for a correction. While the easing of panic in the market has taken the USD index off its recent highs, in our view the USD cannot be expected to weaken decidedly until investors feel confident enough to move back into emerging markets," says Jane Foley, an FX strategist at Rabobank.