Dollar Falls Against Pound as Investors Question September Rate Rise

The pound to dollar exchange rate has been allowed to advance on fears the first US interest rate rise of the coming cycle could be delayed at the US central bank.

Going into this week markets priced the US dollar exchange rate complex at levels allowing for a September rate rise at the US Federal Reserve - any changes to these expectations would see the US currency revalued.

This is exactly what happened when news broke that China was re-pricing their peg on the Yuan. The move signalled to foreign exchange markets that risks to global growth had spiked and as such the excuse to delay pro-USD rises at the US Fed grew.

The US dollar exchange rate complex fell allowing the pound to dollar conversion to break higher.

Nevertheless, we are yet to witness a game-changer for  GBP/USD which remains locked around the 1.56 mark with 1.54 being a level it will not fall and 1.57 the level it will not advance beyond.

The reason the pound to dollar conversion is relatively static is because both the Bank of England will only raise rates after the US Fed; hence a delay at the Fed = a delay at the BoE and the impact is neutralised.

Delaying the Rate Rise

For the USD it appears that the risks are to the downside against the euro and other major currencies, pound excluded.

Analysts at Barclays have told clients that they are becoming increasingly wary that the US Fed will dodge raising interest rates in September.

“The Federal Reserve seems to be working to keep markets from becoming too certain over the possibility of a September rate hike. Over the past two weeks, whenever the market-implied probability of a September rate hike has risen, a Board member has come forward in an effort to tamp down market expectations,” says Michael Gapen at Barclays.

Following the employment report last Friday and the subsequent rise in market implied probabilities, Vice Chairman Stanley Fischer gave an interview on Bloomberg television that has attracted interest.

In the interview Fischer delivered a generally hawkish viewpoint on labour markets but this was countered with a high level of concern over inflation.

Fischer said the Fed should not move before inflation, as well as employment, returns to more normal levels.

It is noted that the Fed member gave no benchmark against which an outsider could judge
progress.

“This absence was especially notable, since inflation trends in Q2, in our view, are already firming toward the Fed’s target. Year-on-year rates of inflation, however, still reflect last year’s energy and import price declines,” says Gapen.

Barclays read the Vice Chairman’s comments as an attempt to retain optionality over
policy.

“We continue to see the first rate hike coming in September, but highlight the risk that the criteria needed to raise rates could shift, as they did in March. In other words, the desire to retain optionality at this late stage may reflect lingering uncertainty within the committee over the appropriate stance of policy,” says Gapen.

As such, the FOMC could decide to postpone rate hikes beyond September for reasons that it has not clearly communicated.

Such a move would present a negative surprise to foreign exchange markets and invite US dollar weakness.

Judging direction in the pound to dollar exchange rate will however be difficult as a delay in the Fed interest rate rise will without doubt delay the anticipated rise at the Bank of England.

Commentators believe that the Bank of England will only move when the US Fed does.

If this is the case we see the main risks coming from the euro which will strengthen significantly against both USD and GBP.

Counter Argument: No Delay to Rate Rise

The impact of third Yuan devaluation has been a lot more balanced confirming currency markets are finding equilibrium and markets are once again more confident on the outlook.

Analysts at Rand Merchant Bank (RMB) do not believe the Fed will delay in the wake of recent events. 

"We still do not buy this story, especially after the yuan and Wall Street stabilisation. We believe Fed hike expectations will bounce back. Fed futures are pricing a 39% probability of a September Fed hike this morning," says John Cairns at RMB.

For the GBP/USD this reinforces the sideways trend which we expect to continue over coming weeks.

Retail Sales Watched for Clues on Fed Rate Hike

Today will be released the retail sales data for July.

Estimates report a change increase of 0.6% from -0.3% in June, mostly driven by strong vehicle sales. Initial jobless claims (New people filing for unemployment benefits) will also coming in today.

“This data is expected to remain in line with prior figure at 270K. Last week non-farm payroll report printed lower than expected at 215k vs 225k. We are still thinking that data are not fully supporting a September rate hike,” says a note on the subject from Swissquote Bank in Gland, Switzerland.