Pound / Dollar Key Data will Guide Sentiment

The Pound to Dollar exchange rate (GBP/USD) trades back at 1.29 at the start of the new week with Sterling looking to recover some of those losses suffered following the release of below-expectation manufacturing data in the previous session.

However, trend-wise, the Pound continues to hold the upper hand. An interesting trend has just occurred in the foreign exchange markets - traders have turned negative on the US Dollar.

According to data that shows how traders on global foreign exchange markets are betting there is a desire to bet on further Dollar declines.

According to CFTC data there has been a $4.7bn deterioration in the USD aggregate, pushing it into bearish territory for the first time since May 2016.

The majority of this deterioration in sentiment comes as the Euro continues to be heavily favoured as a currency that is to appreciate against the Dollar.

But for those watching GBP/USD, markets continue to bet on a further decline. However, the scale of this bet has been pared back reflecting the view that perhaps the exchange rate has seen the worst of its declines come to pass.

GBP/USD has been on a recovery path since January 2017 when levels below 1.20 were recorded. The market is now attempting to break above 1.30.

Thus far, attempts have been unsuccessful yet the overall trend does remain bullish and it would not be a surprise if the pair broke above here in July.

Sentiment against the Dollar has certainly turned negative since it became apparent to traders that US President Trump would struggle to deliver on his campaign pledges to boost investment spending and slash taxes.

There are a number of big-name analysts out there who believe the Dollar’s long-term period of appreciation has come to an end.

The Dollar rallied sharply following Trump’s victory on the assumption he would ignite growth in the US economy.

However, the President’s legislative agenda has stumbled as the reality of cutting taxes and boosting spending became clear - the US would have to endure a substantial jump in national debt, something that does not traditionally sit well with Republicans.

Then there is the Federal Reserve - the Dollar had been rallying through 2016 in anticipation of higher interest rates at the Fed.

The Fed is now well in its tightening cycle and the higher rates story has ceased to have an impact on the USD it would appear.

Data has not been strong enough to justify expectations of a higher interest rate profile; only when economic data picks up notably will we start seeing the Fed interest rate story start to have the positive impact it once had.

That said, July’s release of employment data came in well ahead of expectations. Perhaps the economy is picking up pace again?

If so, the Dollar could be in for a period of appreciation; indeed this is exactly what strategists at JP Morgan are looking for.

“Even as significant parts of rest of the world has been hawkishly repriced, pushing the broad USD to fresh lows, none of these developments invalidate the thesis that US rates need to more fully price in the Fed,” says Daniel P Hui, an analyst with JP Morgan.

What is certain is that data is key to whether Hui and his team are right. With that in mind, there are some important data points to be aware of in the week coming.

Data Releases to Watch this week: US inflation & retail sales

The big macro data comes from the US with key CPI inflation and retail sales numbers that could shift the dial on interest rate expectations.

Last month the Labour Department said its Consumer Price Index dipped 0.1%. The CPI inflation gauge has fallen twice in the last three months. In the 12 months to May, inflation rose by 1.9%, the weakest reading since November.

Meanwhile, the core personal consumption expenditures price index rose 1.4% in May, down from 1.5% the previous month. As recently as February it was as high as 1.8%.

Retail sales – a key driver of the economy – are also losing their lustre, declining by the most in 16 months in May.

“Slacker inflation in recent months has gone against the Fed’s tightening cycle and raised doubts about just how many more times the central bank will hike,” says a note from analysts at ETX Capital in London. “Softer consumer spending and lower inflation is likely to pressure the Fed to row back on its commitment to raise interest rates at least once more this year.”

Complicating the picture, note ETX Capital is the yield on 2-year and longer-dated government bonds has contracted, raising concerns about a potential Fed policy ‘mistake’ that could herald a recession.

“The Fed has been forced to admit that inflation is declining and will not hit its 2% target this year. The worry is that if the Fed hikes too quickly the yield curve will invert with short-term rates above longer-term rates – a scenario that economists fear as it can cripple bank lending,” say analysts at the London-based spread betting and retail trading providers.

However, some better data in the last week or so, coupled with a notably hawkish shift from central banks globally, has seen the yield on the 10-year note rise again, which gives the Fed some breathing space.

“More lacklustre inflation will fuel bets the Fed will hold off further rate hikes, while anything above 2% should see the Fed hold course for now,” say ETX Capital.

This would allow the Pound to recover back towards, and perhaps above 1.30 against the Dollar.