Pound-Dollar: USD Strength Expected to be Fleeting on Temporary Market Angst

- Retail vs. Hedge fund battle rages
- Causes near-term market anxiety
- Dollar bid
- But fundamentals remain negative for USD in 2021 say analysts

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• GBP/USD spot at publication: 1.3689
• Bank transfer rates (indicative guide): 1.3300-1.3405
• FX transfer specialist rates (indicative): 1.3533-1.3590
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The Pound-to-Dollar exchange rate (GBP/USD) fell back ahead of the weekend, retreating to 1.3685 amidst a broader bid for the U.S. Dollar that analysts say is linked to a fall in global stock markets.

The Dollar was bid against its peers on a renewed bout of investor nerves that saw stocks and commodity prices fall, reaffirming the U.S. currency's status as a safe haven asset.

The moves underscore the GBP/USD exchange rate's near-term vulnerability to broader market trends, but a number a number of analysts we follow say the UK's vaccine rollout should provide a fundamental source of support that will limit any weakness.

Above: Major stock markets were in the red ahead of the weekend. Data courtsy of IG.

The source of the Dollar-supportive jitters in global markets appears to be technical in nature and specific to how the market functions, as opposed to having a macroeconomic source of anxiety.

"European markets are on the back foot once more today, with the retail attack on short hedge funds raising fears of a big unwind in the market," says Joshua Mahony, Senior Market Analyst at IG. "One thing is for sure, the Reddit generation have brought significant volatility for markets and provide yet another risk factor to consider for traders."

Above: GBP is down on the day, but the broader market setup remains positive.

Intense speculative market participation by retail traders has fuelled sizeable bubbles in some sectors of the market.

The GameStop share price surge is the prime example and focus of a new phenomenon in equity markets, whereby the stock rocketed and in doing so delivered a savage blow to institutional investors and hedge funds that were betting against the stock.

"While the activity of a small distressed gaming retailer in the US should not have a significant impact on the rest of the world there we believe the situation is causing hedge funds and their funders to go ‘risk-off’ and deleverage their investments causing funds to liquidate positions across the board," says analyst John Meyer at brokerage SP Angel.

Expectations for a volatile close to the week were raised after retail trading platforms reinstated the trade of some the most heavily targeted stocks, including GameStop and American Airlines, having suspended them on Thursday.

"An assault by small investors weaponising call options against hedge fund short positions sparked all kinds of volatility and some legendary short squeezes in smaller stocks. The ripple effects were felt across markets as some funds were apparently massacred on their short bets, forcing them to liquidate profitable long positions to cover those losses," says Marios Hadjikyriacos, Investment Analyst at XM.com.

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"European stocks are a sea of red and Wall Street futures point to another decline at the open today, which would erase yesterday’s rebound. There hasn’t been any news behind this retreat, so it seems that the retail chaos continues to loom in investors’ minds, leading some players to take chips off the table and manage risk," adds Hadjikyriacos.

The crucial reading here is that the source of market anxiety does not appear to be a fundamental basis, rather it is technical in nature and could therefore be short-lived.

"Beyond this short‑term period of turbulence, the reflation theme is intact and a drag on USD. The vaccine rollout is underway, US fiscal policy is about to turn more expansionary and global monetary policy settings will remain ultra‑loose for a very long time," says Elias Haddad, Senior Currency Strategist at CBA.

"We have no inclination to revisit our forecasts for USD depreciation in 2021, amounting to some 5% in index terms, though were recent wobbles to morph into a correction, it would support near-term USD gains," says Ray Attrill, Head of FX Strategy at NAB.