It's FOMC Day - Pound Dollar Exchange Rate Relief Possible

Short-term weakness in the US dollar exchange rate (USD) could transpire over coming days as the US Federal Reserve’s Open Markets Committee (FOMC) briefs the financial market on its approach to that crucial first US interest rate rise of the decade.

“Current GBP weakness is therefore seen as the terminal component of this down-cycle from 2.1165 in 2007 but could extend towards 1.3500 before any macro low is posted again.” – Lucy Lillicrap, AFEX.

The dollar’s rally, now in place since mid-2014, continues to show no signs of letting up with fresh lows seen on the horizon. The thirst for USD has pressured the GBPUSD below the key 1.50 threshold in March 2015.

Those looking to buy dollars with their pound sterling are now facing the prospect of the worst exchange rate since July 2013, but relief could lie ahead.

As we can see momentum is firmly pitted against sterling and the long-term picture suggests more of the same will come over coming weeks and months:

Despite the incessant declines being priced into the longer-term picture, the pound to dollar exchange rate (GBPUSD) could be afforded the chance to rally in coming days with a key event on the currency market calendar likely to trigger the move higher.

Leading up to the FOMC on Wednesday we are expecting trading ranges to narrow before traders pile back into the market.

The financial world will be keenly waiting on the latest communication from the world's largest reserve bank as to when they will start the process of raising interest rates.

Rising US interest rate yields will attract money from across the globe which will duly push up the value of the Greenback.

Analysts expect the FOMC will remove the word “patient” from the statement, suggesting that the decision whether or not to hike will be judged meeting-by-meeting from June onwards depending on the evolution of data.

Note, those with currency market requirements should be aware that the quotes used in this article refer to the wholesale inter-bank exchange rates. When transferring money globaly your bank offers you a rate that has significant margin added. An independent provider will however guarantee to undercut this margin, in some instances delivering 5% more FX. Learn more.

US Dollar: Short-Term Weakness Forecast by Barclays

“We expect the key phrase that the FOMC can be patient in beginning to normalize the stance of monetary policy to be omitted from the statement released on Wednesday evening. Removing “patient” does not signal that rate hikes are coming two meetings later (i.e. in June). But it does give the Fed the flexibility to raise rates at any time they feel it is justified,” says Signe Roed-Frederiksen, analyst at Danske Bank.

Given that removal of “patience” is widely anticipated by the market, the Summary of Economic Projections (SEP) and chair Yellen’s press conference will be more important for near-term prospect of the USD.

As we know, movements in currencies are driven by surprises.

Hence, the USD decline would come if the Fed were to keep the word patient in their statement.

Any declines, or gains for that matter, will also likely come from other quarters.

Yellen’s Tone Predicted to Spark Bout of USD Weakness

The rates research at Barclays expect a somewhat dovish tone with Chair Yellen likely emphasizing the gradual pace of the hiking cycle given the subdued inflation backdrop.

“The dovish touch from the SEP and press conference is likely to weigh on USD in the very near term, but that would likely not change the medium-term upward trend in USD, and we prefer using any post-press conference dip in USD as an opportunity to establish long USD positions at a better entry level,” says the note to clients.

Keep in mind that markets are very ‘long’ on US dollars at present.

This tells us the numbers actively betting on further USD rises are at high levels and any disappointments to expectations could see a quick unwinding in dollar strength as traders are forced to close their positions and sell dollars.

Jeremy Stretch, analyst at CIBC is another industry expert who sees the March FOMC event as being the prime suspect for triggering such a reversal in the USD’s fortunes:

“In the wake of the US economic surprise index plunging last week, to levels not seen since mid ’12, Fed references to policy being data dependent could argue towards the Fed remaining sanguine as regards the probability of early tightening. 

“Alternatively such assumptions could limit the scope of any moves, at the margin tempering, if not yet reversing USD gains.”

Technical Indicators Advocating for a Slow-Down in GBPUSD Weakness

The pound to US dollar exchange rate has, as mentioned, fallen below the 1.50 level.

A look at the charts confirms to us that declines have tended to ease off at these rates of exchange in the past.

Technical analysis is all about forecasting future direction based on past trading action.

As the above shows, GBP-USD tends to find support at present levels and we could make the assumption that support will be found once more.

That said - don’t count on the losses ending here argues Lucy Lillicrap, FX risk manager at AFEX.

Lillicrap says the pound dollar rate is caught in a secular downtrend that must fall towards 1.35 to fulfil historical obligations.

In a weekly client note she says:

“Current GBP weakness is therefore seen as the terminal component of this down-cycle from 2.1165 in 2007 but could extend towards 1.3500 before any macro low is posted again.

“Such an analysis also encourages the scenario for a turnaround in USD fortunes next year and thus suggests rallies in GBP/USD, or indeed EUR/USD etc., beforehand are likely to remain corrective only.”

As such, we see this week’s FOMC event as offering a potential relief rally for those hoping on a stronger British pound.

However, all signs point to it being foolish to start betting that any strength is to be taken as an indicator that the now entrenched downtrend is over.