HSBC Readies for a Dollar Bounce, Pound Said to be Particularly Vulnerable

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The Dollar looks set to bounce back following a period of sustained losses, say strategists at HSBC, who think the Pound is particularly vulnerable.

"A paring back of Fed rate cut expectations should see the USD recover some lost ground," says a strategy note from analysts at the bank, who find the currency now looks cheap relative to fundamentals.

One of the fundamentals in question is the big shift in U.S. interest rate expectations, with investors now favouring an aggressive pace of interest rate cuts in the coming months.

The Dollar fell sharply after a recent speech from Federal Reserve Chair Jerome Powell in which he said the time to cut had arrived. In fact, markets started to see increasing odds of a chunky 50 basis point cut from the Federal Reserve in September, which would be an unusually large move from the Fed outside of crisis.

The USD selloff culminated in the Pound to Dollar exchange rate (GBP/USD) peaking at 1.3266 and Euro-Dollar (EUR/USD) at 1.12.

But HSBC thinks, "this USD adjustment may have run its course." Daragh Maher, Head of FX Strategy for the U.S. at HSBC, says there are two reasons to think this.

Firstly, "even if we accept the market’s suggestion that the Fed could cut rates by 100bp before year-end, the USD looks excessively weak relative even to these dovish rate expectations."

Secondly, "we do not believe the US macro story will warrant this pace of easing, given the lack of evidence of an impending recession, and our belief that a 50bp cut would not be warranted for a ‘soft landing’ scenario.

"Putting the two together, and the fact that the DXY is back at the lows of December 2023, gives us grounds to be bullish on the USD," says Maher.

Maher has his eyes on a GBP/USD pullback in particular, assessing that Pound Sterling looks rich relative to rate differentials and has relied recently on upbeat equity markets for support.

Given the Pound's sensitivity to broader market sentiment, a particular risk to GBP/USD identified by HSBC would be a market selloff linked to fears that the Federal Reserve will commit to a cautious rate-cutting cycle for fear of reigniting inflation.

"GBP looks rich relative to rates, with its strength mostly related to a positive correlation with risk appetite. This leaves GBP vulnerable to any retreat in US rate cut expectations from both a rates and risk appetite perspective. GBP-USD has found the air thin above 1.30 generally, and while positioning is no longer extreme, we see downside risks," says HSBC.