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Pound Sterling is swimming against the tide and attempting a rebound against the Dollar following the Federal Reserve's 'hawkish' policy update and ahead of the Bank of England decision.
The Pound to Dollar conversion (GBP/USD) recovered to 1.2642 on Thursday (+0.50%) as investors pared the excesses of the selloff that followed the Federal Reserve's interest rate decision.
The Fed cut interest rates but signalled it would only cut interest rates twice more next year, whereas the market's assumption was for three cuts.
The readjustment in financial market settings was reflected in rising U.S. and global bond yields, which weighed on stock markets and boosted the Dollar.
"The US dollar has hit fresh year to date highs overnight following the hawkish policy update from the Fed. It has helped the US dollar to regain upward momentum lifting the dollar index to a high of 108.27," says Lee Hardman, Senior Currency Analyst at MUFG Bank Ltd.
But the British Pound has resisted the Dollar's advance better than most, courtesy of the UK's elevated interest rates. In fact, screened over a one-day and one-week period, GBP is the second-best performing G10 currency.
UK bond yields continue to rise in response to developments at the Federal Reserve. Markets reckon that a slower Fed means the Bank of England will have limited space to accelerate the pace at which it cuts interest rates in the coming months.
The Bank will forgo another interest rate cut on Thursday and will also find its hands will be tied by rising UK inflation rates at the turn of the year.
So, like the U.S., the UK will see interest rates elevated relative to most peer economies, creating a mechanical draw for the GBP and USD.
But, for GBP/USD itself, the outlook remains tilted lower. After all, the U.S. economy commands higher interest rates courtesy of its robust economic growth. The UK, on the other hand, will struggle under the weight of high inflation (necessitating higher interest rates) and low economic growth as businesses toil under growing bureaucracy, an expanding public sector and rising taxes.
Economists point out this is a 'stagflation lite' setup, which is not necessarily a mark of confidence for the Pound.
Despite a relief rally on December 19, the GBP/USD looks heavy from a technical perspective and a retest of November lows at 1.2486 looks possible.
Potentially denying such a move would be calmer market conditions into year-end and a realisation that a lot of 'good news / 'hawkish' Fed expectations are now in the price of the Dollar.
Could the market conceivably lower expectations further, potentially seeing no rate cuts in 2025?
This is possible, but it is worth noting that the current rise in bond yields implies higher lending costs. This will hit confidence and further rises will seriously risk a more protracted slowdown.
In response, the Fed would have to cut.
Peak dollar might be near.
"For the year ahead, we mostly see the USD remaining resilient during H1 before turning lower in H2 vs most G10 currencies," says a note from Bank of America. "The macro picture remains supportive, but upside USD risks from the election are well priced, while downside risks overlooked."