GBP/USD: Down Trend Stalling as US Inflation Numbers Disappoint

The decline in the GBP/USD exchange rate has stalled after U.K employment data supported GBP but U.S CPI weighed on the dollar; add to that increasingly doveish monetary policy outlooks for both, and you have a recipe for a sideways consolidation.

GBP/USD has started to consolidate after putting in the first positive daily close for seven consecutive days.

The pair, which had previously been trending steeply lower, stalled after U.K employment data lent support to the fundamental outlook for the pound whilst U.S CPI missed expectations, putting pressure on the dollar.

A narrowing of the previously diverging monetary policy agenda's of the two currencies' central banks also helped support GBP/USD exchnage rate as hopes of further rate hikes for both diminished.

From a technical perspective the pair is deeply oversold, sporting an RSI(14) of 18.59, which is well below the 30 distinguishing oversold conditions.

The exchange rate has also reached a key level which represents the height of the descending wedge pattern it recently broke out of extrapolated down.

It is now almost exactly at the 100% extension point of the wedge's height, at 1.4180; an expected 'hopping off' point for many bears after the ride down, and the likely level for a raprochement.

According to Swissquote:

"the general oversold conditions and the recent pick-up in buying interest pave the way for a rebound.”

Analyst Richard Perry, of Hantec Markets, however, is more sanguine:

"A 37 pip rally may not sound a lot but the bulls have been feeding off scraps recently and they will take anything they can get right now.

"The first positive (or should that be non-negative) candle we have seen on Cable for weeks has done little to change the outlook and looks to be more of a pause for breath if anything."

Perry sees the recovery as probably nothing more than a pull-back in a "step-decline" lower, and expects a "retest of the 1.4125 lows" as eventually resulting in a breakthrough down to 1.4000.

Meanwhile Karen Jones of Commerzbank would ideally like to see a break above 1.4229 before turning bullish:

“Ideally we would like to regain 1.4229 the May 2010 low. This was a major support zone for the market, and a recovery above here would add weight to the idea of a corrective rebound."

U.S CPI Misses

Wednesday's data showed that U.S headline inflation rate showed a 0.7% rise yoy in December, which was a marked increase from the 0.5% in the previous year, although it fell below the 0.8% expected.

On a month-on-month basis Prices in December fell by -0.1% compared to November’s 0.0% and below consensus forecasts that they would remain unchanged.

Core inflation mom also fell a basis point below expectations – however the yoy Core rate met expectations of a 2.1% rise in prices – and constituted the main bright spot in the survey.

Economist Josh Nye of RBC economics analysed the figures as generally positive despite the expectation misses:

“The annual readings for both headline and core consumer price index (CPI) continued a gradual march higher in December, each finishing 2015 at its highest levels of the year.”

Nye also pointed out the rise in inflation was all the more impressive when considered against the offsetting backdrop of a strong dollar, reducing the price of imports, and falling energy prices.

“The increase in core prices to a 3.5-year high comes despite downward pressure from lower import prices, thereby reflecting a strong US dollar and some spillover from falling energy prices. “

The RBC economist pointed out that the rise in Core CPI could not solely be explained by rising house prices as in the past, but was also now more broadly based, showing more inflationary strength and depth:

“While it continues to be the case that the shelter component (3.2% year-over-year in December) is boosting core CPI; that factor has been relatively constant during the last year, and thus, the gradual pickup in core inflation in 2015 also reflects general upward pressure on prices due to limited slack in the economy. “

The inflation data was supportive of the Federal Reserve’s current policy strategy of accommodation withdrawal:

“Our forecast assumes core inflation will remain at or above 2% throughout 2016, which should improve the Fed’s confidence that it can achieve its 2% inflation objective in the medium term, even with a gradual withdrawal of monetary policy stimulus.”

Unlike the majority of investors RBC expect the Fed to stick with its current dot-plot outlook for four rises in 2016 – or 100 basis points overall:

“While we expect the fed funds rate will be held steady in January, we continue to look for 100 basis points of rate hikes this year.”

Investors Tone Down their Fed Hike Expectations in the Teeth of Worsening Global Conditions

RBC’s expectations that the Fed will make 100bps of hikes this year is at the hawkish extreme of the current spectrum of institutional investor’s expectations, according to a survey of global fund managers from Bank of America Merrill Lynch, which released its findings on Wednesday.

The survey showed that the consensus had shifted to between two and three hikes in 2016, with the majority expecting two; this was a change from November’s data which showed the majority expected three.

Their reasons were primarily risks from China and the worsening condition of the global economy, which the IMF recently revised down growth forecast for in 2016.