Pound-to-Dollar Rate in Retreat as Caution Pervades ahead of Federal Reserve Policy Update

- GBP in retreat as stocks wobble, USD recovers footing ahead of Fed.
- Wednesday's statement key to outlook for stocks and risk currencies.
- USD rebounds against all other than JPY and CHF as S&P 500 slips.
- 1.2468, 1.2318 to offer support to GBP as USD Index targets 99.44.

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The Pound-to-Dollar rate was lower and the greenback in comeback mode Tuesday as caution prevailed ahead of the latest Federal Reserve (Fed) policy update that will be decisive in determining whether the raucous recovery in stock markets continues without meaningful setback.

Pound Sterling crumbled in the face of a recovering Dollar Tuesday as risk appetites were tempered ahead of Wednesday's Fed policy update that will dictate the mood in markets through until the weekend and beyond given how the bank has been instrumental in driving the equally historic stock market recovery off March lows. That has in turn, picked risky currencies of all stripes up off the floor in recent months.

The bank's yield-crushing policies have lifted the risk premiums paid to investors who own shares and have made a text book argument in favour of higher valuations multiples, even though the global economy is still in a hole. But large 4% gains for many major equity benchmarks in the last week are an argument for caution ahead of Wednesday's 19:00 policy decision, which will be followed by a press conference at 19:30.

Markets are looking for Chairman Jerome Powell to commit to keeping the Fed's foot pressed hard on a metaphorical monetary policy pedal that's been pushed to new extremes to combat the coronavirus pandemic. 

"All eyes are on the FOMC meeting tomorrow as the equity market pulled back slightly at times overnight after a couple of days of strong gains. Market participants need to question at this point whether they will receive a sufficiently supportive message from the FOMC meeting tomorrow night now that the S&P 500 Index has reached a positive year-to-date performance. Elsewhere, the JPY spike higher demands the attention of FX traders," says Steen Jakobsen, chief economist and investment officer at Saxo Bank. 

Above: Pound-to-Dollar rate shown at daily intervals alongside S&P 500 futures (orange line).

The Pound-to-Dollar rate was down -0.74% at 1.2641 Tuesday, a meaningful decline but one that follows a week-long rally that carried the exchange rate more than 2% higher in the five days to last Friday. Sterling was also lower against most rivals in the major currency complex, although all major currencies other than the Yen and Franc also ceded ground to the U.S. Dollar. 

"We’re getting closer to the end of this leg of USD weakness," says Bipan Rai, North American head of FX strategy at CIBC Capital Markets. "The time is right to harvest gains rather than establish fresh shorts against the USD. However, that doesn’t mean that we’re turning bullish. There are still compelling strategic narratives to remain suspicious of USD gains. More on that later."

The Dollar was higher against most rivals but especially the currencies that were seen to benefit most from rip-roaring stock markets in recent weeks, which left the commodity-sensitive Australian and New Zealand Dollars reeling while also clobbering Sterling and the Canadian Loonie.

This was as S&P 500 futures dipped ahead of the North American open, reversing gains from the prior session when a 10-week rally culminated in the benchmark swinging back into the black for 2020.

Meanwhile, the Dollar Index was quoted at 96.89 after bouncing off the 78.6% Fibonacci retracement of its March uptrend around 96.43, with Pound-to-Dollar and Euro-to-Dollar rate losses firmly in the frame for the benchmark's 0.28% gain. Those two account for more than two thirds of flows measured by the ICE Dollar Index, which was up just 0.49% for 2020 on Tuesday. 

"GBP/USD there is scope for a test of the 78.6% retracement at 1.2818 (of the move down from the March peak). Given that we have a TD perfected set up on the daily chart and a 13 count on the 240 minute chart we suspect that this will hold. Dips lower should find initial support at 1.2468/86 ahead of the short term uptrend at 1.2330, which is expected to hold the downside," says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank, who looks for the Dollar Index to run out of steam at 99.44.

Above: Dollar Index shown at daily intervals with Fibonacci retracements of March spike higher marked out.

Tuesday's price action came as investors and analysts questioned whether there's anything the Fed could say on Wednesday in order to sustain the rally in stocks that's been key to taming the once-runaway Dollar and breathing life back into non-safe-haven currencies like the Pound and smaller commodity Dollars. That rally has arguably been driven as much by the equity market implications of Fed policy as it has the expectations of a swift and robust global economic recovery from the coronavirus. 

"We find a strong correlation between the USD and global equities and show risk-on currencies have performed the best," says Athanasios Vamvakidis, head of FX strategy at BofA Global Research. "Although we can justify some weakness in the USD from the massive macro policy stimulus, we remain concerned about a weak global recovery and keep a bullish USD bias. We also see risks that COVID-19infections could increase, at the same time as data improve, during the opening of the lockdown."

Tuesday's price action also came as a number for Dollar-supportive fundamental risks built further in the background, with World Health Organization officials having added credence on Monday to fears of a second wave of coronavirus infections. It said the global situation is worsening even though Europe and North America have now largely contained the disease, as increasing cases in the Americas and some parts of Asia are re-steepening what was once a flattening global epidemic curve.

Meanwhile, tensions between China and the rest of the world continue to build. Chinese fighter jets were reported to have entered Taiwanese airspace overnight and the South China Morning Post offered up images of more soldiers being despatched toward the Indian border where there is a land dispute between the two nuclear armed countries. In addition, fears continue to mount for January's 'phase one deal' that largely ended the trade war between the world's two largest economies.

"If Trump continues to decline in the polls against Biden, there’s a VERY strong chance he’ll double down on anti-China rhetoric and action. That includes possibly tearing up the phase one agreement that both sides signed in January. Keep an eye on the polls as they come in – even if we’re still months away from the election," says CIBC's Rai. "A corrective tone to recent market behaviour has the trade-weighted USD up on the session so far. As you’d expect, most of these gains are against the higher beta currencies. We see evidence that the greenback will need some time to consolidate here."

Above: Euro-to-Dollar rate shown at daily intervals alongside S&P 500 futures (orange line).