Pound / Dollar: MUFG, ING Look for USD Strength into Year End

Above: Federal Reserve Chairman Jerome Powell will be in focus for USD midweek. File image © Federal Reserve.

The U.S. Dollar is tipped to remain dominant into year-end with a number of institutional analysts we follow, a call which if correct suggests further downside pressure on the Pound to Dollar exchange rate is due.

The calls comes just a day before the Federal Reserve's December policy meeting where investors anticipate policy makers will announce a desire to speed up the pace at which they slow their quantitative easing programme.

"USD to gain," says Lee Hardman, Currency Analyst at MUFG. "Difficult for the FOMC to out-hawk market pricing but enough to keep the US dollar supported."

The ending of quantitative easing in the first half of 2022 would allow for the Fed to then raise interest rates; offering supportive dynamics for the Dollar in a world where other major central banks continue to proceed with caution.

"The message from the FOMC and Fed Chair Powell on Wednesday is likely to emphasise the flexibility in the pace of QE given the heightened risks. The Evergrande formal default and the policy shift of the Chinese authorities in favour of a stronger USD will be factors that will increase Fed concerns over global risks," says Hardman.

The Dollar is up against all its G10 rivals in 2021, with an advance of 3.50% now being recorded against Pound Sterling and a gain of 8.3% coming against the Euro.

• GBP/USD reference rates at publication:
  Spot: 1.3218
• High street bank rates (indicative band): 1.2855-1.2948
• Payment specialist rates (indicative band): 1.3099-1.3150
• Find out about specialist rates, here
• Set up an exchange rate alert, here
• Book your ideal rate, here

Driving the Dollar higher through 2021 was the outperformance of the U.S. economy which in turn invited investors to raise expectations for higher interest rates at the Fed during 2022 and 2023.

But, the one risk to those betting on a stronger Dollar from here is that these expectations soon reach their limit: there must after all be a limit to the number of hikes the Fed can deliver in the next two years before the economy turns lower as a result.

"So with so much now priced, it is hard to see the Fed triggering a substantial further shift higher in yields," says Halpenny.

But MUFG anticipates hotter inflation readings and an end-projection for fed funds closer to the long-run 2.50% level to come out of the Fed meeting.

This "will certainly support yields and likely see some further USD strength," says Halpenny. "We remain sceptical of the Fed ultimately delivering what’s priced for next year but for now further gains for the dollar versus low-yielding currencies like EUR and JPY looks set to continue."

Chris Turner, Global Head of Markets at ING says a hawkish Fed looks set to keep the Dollar supported.

"Wednesday's FOMC meeting should see the Fed shift its stance on inflation and announce a faster pace of tapering of its bond purchases," says Turner in a regular client briefing.

ING's FX strategists are "particularly interested" in the Fed's Dot Plot guidance on future interest rates, which they believe turned the bearish Dollar trend around in June this year.

"Assuming the Fed does shift to a median expectation of two hikes in 2022, we would expect US money market rates to push higher again, taking the dollar with it," says Turner.

Equity returns out of the U.S. are meanwhile also seen as a driver of Dollar demand that is unlikely to dry up in the near-term: indeed, ING note the bar to restrictions in the U.S. remains resolutely high when compared to Europe.

This suggests U.S. equity outperformance as Omicron cases drive global infection rates higher once again.

"It is probably a consensus view now, but we think nearly three weeks of consolidation have seen the dollar correct from its overbought levels in late November and a hawkish Fed can be the catalyst for pushing DXY to new highs for the year," says Turner.