Pound to Remain Pressured by Dollar as Fed 'Pivot' Proves a Damp Squib says Bank of America

• USD fell in Oct. as Fed 'pivot' expected
• Midweek meeting of Fed is week's key event
• But even a pivot won't dent USD says Bank of America
• U.S. payrolls due Fri.

Image © Adobe Images

The Dollar is expected to remain dominant and bring an end to the British Pound's recent recovery by analysts at Bank of America, who says any near-term Federal Reserve 'pivot' is no game-changer for global FX.

The Pound to Dollar exchange rate ended October on a sour note by falling a percent, the declines coming just days ahead of the crucial midweek meeting of the U.S. Federal Reserve, where another rate hike of 75 basis points will likely be delivered.

October was nevertheless a month of recovery for Sterling, as GBP/USD notched up a 3.0% gain, going as high as 1.1646 on October 27.

Much of this improvement can be attributed to the rejection of the economic policies of Liz Truss and her Chancellor Kwasi Kwarteng, but expectations for policy changes at the U.S. Federal Reserve have played a sizeable part in the Dollar's retreat.

The Dollar was sold last week after expectations grew for the Fed to turn more cautious and signal maybe the time had arrived to slow the pace at which it hikes interest rates.

Expectations for such a pivot rose following a Wall Street Journal article and comments from Federal Reserve President Mary Daly that suggested Fed officials will want to "step-down" the pace of rate hikes.

"A WSJ article by the same author several months ago intimated that a 75bp hike was coming at the June FOMC meeting; until publication of that piece, the market was expecting a 50bp increase. That article not only moved market pricing in short order the Monday before the decision, but also proved prescient: the Fed did indeed deliver the jumbo-sized move broached in the article," says John Velis, FX and Macro Strategist at BNY Mellon.

The Dollar fell and stocks rose as investors sensed a potential shift in policy, but one major investment bank and lender says although the Fed will potentially reduce the tempo on rate hikes, the Dollar will retain its strength.

"We look for a 75bp rate hike. We expect the Chair to open the door to a slower pace of hikes beginning in December," says Michael Gapen, U.S. Economist at Bank of America.

"Yet we expect the Fed to remain data dependent and emphasize cumulative policy rate tightening over any step down in pace," he adds.

Above: GBP/USD at four-hour intervals, showing October's recovery. To better time your payment requirements, consider setting a free FX rate alert here.

The 'cumulative policy rate' refers to the total amount of hikes the Fed will deliver: even if the pace of delivery slows a sizeable amount of tightening remains on the cards.

Currently, the market anticipates a further 135 basis points of hikes from the Fed by year-end, with a peak in the Fed Funds rate residing at around 5.0% by the first quarter of 2023.

"The November decision should be supportive for the USD in the near term," says John Shin, FX Strategist at Bank of America.

Shin adds that although the Dollar is at around 40-year highs, strength will "linger around such levels into the start of next year".

This suggests the Euro and Pound will remain under pressure against the U.S. Dollar over the coming weeks.

(If you are looking to secure your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here).

"Inflation, and the central bank response to inflation, has been a key USD-positive force, and is likely to continue to be positive for the USD near-term," explains Shin.

Should the Federal Reserve surprise and signal a "more hawkish" stance than is currently expected, the Dollar would likely be better supported.

"Macro fundamentals such as continued persistently higher inflation could well dampen such expectations for the Fed to slow down, keeping USD elevated. Conversely, a dovish surprise from the Fed would likely help push the dollar lower," says Shin.

Beyond the mid-week outing from the Fed markets will also pay close attention to the U.S. jobs report, due Friday.

The report is expected to confirm the U.S. labour market remains in robust shape, with markets looking for 200K jobs to be added.

A strengthening Labour market would keep pressure on U.S. wages, in turn ensuring core inflation readings remain well above the Fed's 2.0% target.

This could therefore be a week that sees the Dollar reassert its dominance.