Pound Reels as Dollar Strength Haunts Market Afresh

"We suspect this renewed strength for the US dollar will persist going forward," Derek Halpenny, MUFG

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The Pound to Dollar exchange rate fell back beneath the 1.20 handle and near to its lows for the year ahead of the weekend after upbeat U.S. economic figures and hawkish commentary from Federal Reserve (Fed) officials were followed by a Dollar rally that left Sterling and a selection of other currencies reeling. 

Sterling had better resisted the clutches of a strengthening Dollar through much of the week, leading to a resilient performance against other currencies, although the U.S. unit got the better of the Pound late on Thursday and had left it trading as an underperformer by Friday even after July's UK retail sales figures came in stronger than expected by the market. 

"The dollar continues to retrace the mid-July to mid-August sell-off. It is hard to pin down the exact reason for dollar strength – after all, US yields have softened a little over recent sessions," says Chris Turner, global head of markets and regional head of research for UK & CEE at ING.

"It is fair to say sterling remains fragile. However, it looks more vulnerable versus the dollar," Turner and colleagues said on Friday.

The latest Dollar gains built alongside what were at best some lethargic increases in U.S. bond yields and did not keep stock markets in the U.S. and elsewhere from rising.

Above: Pound to Dollar rate shown at hourly intervals with 02-year and 10-year U.S. bond yields.

Dollar gains were selective on Friday for impacting the Pound and Japanese Yen more so than many other major currencies and in the same way as Thursday's rally took a heavier toll on the Pound and European single currency, both of which fell more heavily than the Turkish Lira on Thursday.

"EURUSD is on its way to threatening parity once again, GBPUSD plunged well below 1.2000 and the Chinese renminbi is at its weakest levels against the US dollar for the cycle," says John Hardy, head of FX strategy at Saxo Bank. 

"All traders should keep an eye out here for whether China allows a significant move in the exchange rate toward 7.00, and particularly whether CNH weakness more than mirrors USD strength (in other words, if CNH is trading lower versus a basket of currencies)," Hardy also said on Friday.

The Dollar Index rose back toward its high from mid-July during Thursday's price action and Friday's follow-through, which came after one measure of new U.S. unemployment claims surprised on the downside of expectations and following a strong increase in the Philadelphia Federal Reserve Manufacturing Index.

Above: Pound to Dollar rate shown at hourly intervals with Dollar Index and EUR/USD.

The increase in the Philadelphia Fed manufacturing index was in contrast to the record-setting slump in the New York Fed's Empire State Manufacturing Index released on Monday although, and perhaps more significantly, the Dollar rally also came amid a wave of hawkish remarks from U.S. policymakers.

"Messages from Fed officials continue to point to further upside to US interest rates. Yesterday Kashkari said the FOMC has an inflation problem now and therefore has ‘more work to do’ in raising rates," says Kristina Clifton, a senior economist and currency strategist at Commonwealth Bank of Australia.

"Bullard supported another 75bp rate hike at the September meeting in order to put significant downward pressure on inflation. George noted the FOMC has already ‘done a lot’ on tightening policy, but the case for further rate hikes remains strong. Markets now await the annual Jackson Hole symposium late next week," she added on Friday.

Thursday's appearances from Fed officials included one from St Louis Fed president James Bullard who told The Wall Street Journal that he is open to the idea of a third consecutive 0.75% increase in the Fed Funds interest rate for September, which is a prospect that had been all but priced-out of the Dollar over the latter half of July.

Above: 02-year and 10-year bond yields for UK and U.S. governments. 

Meanwhile, San Francisco Fed president Mary Daly reiterated in an interview with CNN that financial markets are mistaken to continue betting that the Fed might be likely to begin cutting its interest rate next year and soon after it reaches its market-anticipated peak around 3.75% in May 2023.

Fed policy commentary continues to pose upside risks to U.S. bond yields while threatening further losses for other non-Dollar currencies, although short and longer-term U.S. government bond yields actually fell at times during Thursday's Dollar rally and the 10-year yield was struggling for traction again on Friday.

"We suspect this renewed strength for the US dollar will persist going forward and as we have stated here, there is scope for the very front-end of the US rates curve to price in more monetary tightening by the Fed," says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG.

"The GBP/USD rate has broken back below the 1.2000 level and a recent build-up of long GBP positioning by Leveraged Funds could be vulnerable to liquidation propelling GBP/USD lower still," Halpenny wrote in a research briefing ahead of the weekend.

Above: Pound to Dollar rate shown at daily intervals alongside EUR/USD.