It's Make-or-Break for Pound Against US Dollar as Key Support is Tested

The US Dollar has been the best-performing currency in the G10 complex through the course of the latter half of the week.

As a result, we see the Pound to Dollar exchange rate fall back to 1.2536 and the Euro to Dollar exchange rate down to 1.0664.

We note in this piece that the Pound is in fact at a key support level that must hold if the uptrend is to remain relevant.

The US Dollar index - the broad measure of overall Dollar strength - was seen up by 0.62% at 100.75 at the time of this article's latest update.

The recovery in the Dollar goes against a trend of Dollar weakness that has largely characterised FX trade in 2017.

“The greenback has got a little bit stronger and the Dollar Index is again trying to form a base around that 100 level. It looks like the EUR/USD’s rally has run out of juice, the USD/JPY has bounced back and now GBP/USD could be the next domino to fall,” says Fawad Razaqzada, Market Analyst at Forex.com.

Dollar bulls are back in control and they have taken the buck higher against all of the major currencies.

The Dollar had lost ground through the course of January as markets waited for more juice to fuel the currency's rally - that juice being communication from Donald Trump.

The Dollar tore higher following his election victory in November with markets rushing to account for an expected increas in spending, tax cuts and tax breaks under his reign.

However, we are still short on detail when it comes to these policies and there is the real risk that markets have bought the rumour and may sell the fact when they plans are revealed.

“The US Dollar has one more near-term bout of strength left in it, but after Q1 the currency will underperform. In the absence of aggressive trade restrictions or greater than expected fiscal easing, the greenback will depreciate against a number of majors,” says Royce Mendes at CIBC Economics in Toronto.

Dollar Catches Bond Yield Rally

The source of the current jump in the Dollar appears to be a rise in the yield offered on short-term US Government debt - in other words US interest rates are rising.

"Dollar bulls are back in control and they have taken the buck higher against all of the major currencies,” says Kathy Lien, Director at BK Asset Management. “The Greenback was lagging and not diverging from US equities and interest rates but that divergence came to an end today with the currency breaking sharply higher.”

We have noted how yields have been supporting Pound Sterling of late, now it appears that they are supporting the Dollar.

"The USD is benefiting from short-term yield spreads turning supportive even with a slew of mostly negative fundamentals today," says a note from the Olympia Trust Company.

Indeed, the Dollar has moved higher as Unemployment Claims missed the mark coming in well above the 247K expectation at 259K. 

New Home Sales also missed the mark coming in at 536K vs. the forecast 585K. 

Rising bond yields support currencies as foreign exchange inflows rise as foreign investors seek out an improved return on their investments.

Outlook for the Pound vs Dollar: Breaking Down

GBP/USD appears to have established a significant long-term bottom at $1.20 having bounced off here earlier this month.

“It could be on the way of hitting $1.30 in the coming weeks,” says Razaqzada. “BUT today, the bullish trend looks to have come to an end as far as the short-term outlook is concerned.”

The 4-hour chart of the cable, below, shows that price has respected resistance at the 1.2650 area – this being the last support pre-breakdown (circled).

“Consequently, it may pull back towards 1.2530-50 area (prior resistance) before potentially bouncing back. However a much deeper correction could be on the way if this area fails to hold as support,” says Razaqzada.

At the time of writing we are at this potential support - so it is make-or-break for the Pound against the Dollar.