GBP/USD: FOMC Decision Day is Here

The pound to dollar exchange rate (GBPUSD) has entered a tense side-ways trading pattern ahead of an important mid-week event.

Those watching the movements of the GBP and USD on global currency markets could well see the exchange rate make significant moves on Wednesday when the decision-making body at the US Federal Reserve (FOMC) meet again.

They are expected to communicate when that much-awaited first interest rate hike will come. For foreign exchange the movement of global interest rates are front and centre of determining value.

The US dollar has enjoyed a strong run over recent months in anticipation of higher interest rates. However, GBP/USD has since started moving sideways since March suggesting that market participants still doubt the lift-off in US ineterest rates will come soon

"The U.S. dollar traded lower against all of the major currencies today after the meltdown in Chinese stocks raised concerns about whether the weakness in China will prevent the Federal Reserve from raising interest rates in September," notes Kathy Lien at BK Asset Management. 

For now traders are adopting a wait-and-see approach and not wanting to put too much risk on the table ahead of the event. Looking at the markets:

• The spot inter-bank pound to dollar exchange rate is quoted at 1.5615 at the time of writing.
• UK high-street retailers are delivering around 1.5178 for international payments.
• Independent providers are seen providing a rate closer to 1.5428.

The Outlook for GBP-USD Depends on the FED

The FOMC will meet on Wednesday and the Q2 GDP figure will come in a day later on Thursday.

“All eyes will then be focused on the US as September lift-off remains a true concern. Indeed, the Federal Reserve has prepared markets for a rate tightening this year, but surprisingly Janet Yellen, in her speech held in Cleveland earlier this month, did not appear so optimistic about the US recovery,” notes Yann Quelenn - Market Analyst with Swissquote Bank.

Yellen did mentioned that a first rate hike will happen at some point later in the year and that will be the starting point of a normalising monetary policy.

Despite such comments, mostly made not to scare markets, Swissquote think that the low inflation, which printed for June at 0.3% q/q while it remains quasi flat at 0.1% year-on-year, confirms data are not fully supporting a rate hike in September.

This is an undeniably US dollar negative view, and if correct, will allow the pound to dollar exchange rate to rally back towards the top of its recent range in our view.

Indeed, wages are pressured down and this brings more difficulties for households to repay their debts and mortgages.

US New Homes Sales printed last Friday well below expectations at 482K vs 548 confirming a general lack of momentum in the eco-stats at present.

With regards to the technical outlook for sterling / dollar support is seen at 1.54 and resistance to upside moves at 1.56.

These two figures represent the preferred range for the exchange rate at present and should provide some gravity over coming weeks.

As such, any moves either side will likely end with a return back into the range.

Long-Term Dollar Strength Ahead

"Overall, we think the USD should appreciate in both “risk-on” and “risk-off” states of the world. In “risk-on” states, superior US economic fundamentals are likely to support higher returns to capital and currency appreciation. In “risk-off” states, the USD is likely to be supported by its highly attractive safe-haven attributes including low volatility in asset returns," say Barclays in a note to clients.

For researchers at Barclays there are a number of factors converging on a pro-USD outlook with the superior return on capital investment in the US being the main driver.

Indeed, it is argued by analysts that returns in the US are fast approaching returns that one would normally associate with developing markets.

Then there is the safety of the dollar. Analysts see no reason for the USD to be the safe harbour in times of turmoil, something that has become increasingly relevant as Chinese stock markets fall off a cliff.

Recent data has also confirmed economic trends are supportive of higher interest rates, and by extension, higher exchange rates.

Dennis de Jong, managing director of UFX.com, has reacted to data released at the start of the week that shows US Durable Good orders grew by 3.4% in June, ahead of forecasts for 3%:

“It’s a vital week not only for the world’s largest economy, but for the many observers around the world keen to take their cues from the Federal Reserve’s decision on interest rates.

“The figures released today will give Fed Chair Janet Yellen further belief that a rate rise is needed sooner rather than later. However, a prompt move would come as a surprise to the markets, and a September hike still seems most likely.”