The pound to dollar exchange rate (GBP/USD) slid below the $1.22 level, hitting its lowest point since mid-March and heading for its weakest monthly performance in a year. The drop came as investors processed disappointing economic data and the Bank of England's decision to halt its rate hike cycle last week.
Following its remarkable 5% surge in the first half of this year, which marked the strongest performance among major developed currencies against the U.S. dollar, the pound is now falling behind once more.
Concerns over sluggish growth prospects, persistent Brexit-related uncertainties, doubts surrounding long-term debt sustainability, and stubborn inflation issues have all made investors wary of holding U.K. assets.
“For most of this year the market was thinking the UK had avoided recession and that rates there would be going up a lot more, providing an incentive to buy the pound,” Jane Foley, head of FX strategy at Rabobank, said in a comment to the FT. “That’s no longer the case.”
The S&P Global Purchasing Managers' Index (PMI) report, released on Friday, revealed that business activity in the UK contracted at the steepest rate in over two and a half years in September, largely due to reduced demand caused by rising living costs and increased borrowing expenses. Excluding pandemic-related disruptions, this decline marked the most significant drop in activity since March 2009.
On the policy front, the Bank of England kept interest rates unchanged at its September meeting but signaled its commitment to maintaining elevated interest rates for a longer period of time — the policy stance, shared by the U.S. Federal Reserve (Fed) and the European Central Bank (ECB), is commonly referred to as “higher for longer”.
“Sterling’s had a bad month because the UK’s had the biggest drop in peak rate expectations compared with other major economies,” said Kit Juckes, a macro strategist at Société Générale, told the FT. “Rate support for the currency has vanished.”
In November, U.K. policymakers are expected to maintain the Bank Rate at 5.25%, considering indications of easing inflation and a more relaxed labor market. Markets are currently pricing in a 50% probability that there will be no further increases from the current 5.25% rate.
The GBP/USD currency pair — often called “cable” in forex markets — is also facing pressure from renewed strength in the U.S. dollar (USDX), bolstered by the Federal Reserve’s commitment to another rate hike before the end of the year. On Monday, two Fed officials, Chicago Fed President Austan Goolsbee and Minneapolis Fed President Neel Kashkari, both reiterated the central bank’s intention to keep interest rates “higher for longer".
Long-term U.S. Treasury bond yields have soared on the news. Ten-year U.S. Treasury yields surged by an impressive 25 basis points within a single week, reaching a new 16-year high of 4.5660% early on Tuesday. According to Deutsche Bank, this level holds historical significance, considering that the average 10-year yield dating back to 1799 has been around 4.50%.
Thirty-year U.S. Treasury bond yields saw an increase of over 30 basis points in just one week, soaring to a 12-year high of 4.6840%.
Private sector bankers are starting to brace for the worst, with JP Morgan chief Jamie Dimon reported overnight as warning:
"Going from zero to 2% was almost no increase. Going from zero to 5% caught some people off guard, but no one would have taken 5% out of the realm of possibility. I am not sure if the world is prepared for 7%.”
Markets are also watching news surrounding the possibility of a U.S. government shutdown. A conflict between House conservatives and Speaker Kevin McCarthy, who previously negotiated a spending agreement with President Joe Biden, appears to be growing more difficult to resolve.
Scotiabank Chief Currency Strategist Shaun Osborne said the dollar was likely to exhibit short-term strength, but was prone to a downswing on weak economic data or a U.S. government shutdown:
“The risk of more, at least short-term strength in the USD is high, given momentum, but there is a risk that positioning and sentiment are shifting too far, too quickly, leaving markets prone to a USD downswing in the event of adverse fundamental news – a weak data print or two – or even a US government shutdown.
Short term price signals suggest a brief pause perhaps in the broader USD rise.”
As the dollar probed November 2022 highs after its tenth successive weekly gain, Kit Juckes, Chief Global FX strategist at Societe Generale, weighed in his take on the greenback’s strength in his USD forecast:
“Shutdown and downgrade concerns, month and quarter-end, talk of the US economy growing forever and forcing the Fed to do more and inflation worries have all been cited as reasons for the latest lurch higher in US yields, but I’ll go on favouring the need to offer higher yields to attract sufficient money to finance an endless stream of Treasury auctions.
The world must reallocate more of its capital to US bonds, and higher yields do the work, which then results in a stronger Dollar as more money either stays in the US or is attracted from abroad. This will provide the conditions for the US to slip into recession in 2024 and for the Dollar to weaken once the dust settles. In the meantime, the data are robust, and the Dollar is strong.”
Turning to the GBP/USD pair, Scotiabank’s Shaun Osborne said cable could be oversold in the short run:
“Cable price signals are reflecting a tentative and perhaps only short-term base for the GBP developing on intraday chart. The GBP sell-off does look somewhat overextended so a minor relief rally would not be a surprise at this point.
Gains through 1.2200 intraday would be a minor positive for the GBP and perhaps trigger a squeeze to the 1.23 area where firmer short-term resistance should emerge. Intraday support is 1.2160/1.2170. Broader risks are tilted towards a drop back to the 1.20/1.21 area.”
A similar technical perspective from economists at Societe Generale, quoted by the FXStreet Insights Team, was bearish on GBP/USD, saying a meaningful uptrend for pound to dollar rate could only be achieved if the rate rose back up to $1.2430:
“GBP/USD confirmed a Head and Shoulders and subsequently gave up the 200-DMA resulting in steady decline.
Daily MACD is now within deep negative territory denoting a stretched move however signals of reversal are not yet visible.
The pair is expected to drift towards target of the formation near 1.2170/1.2100. Achievement of these objectives could result in a bounce. However, reclaiming the 200-DMA near 1.2430 would be essential to affirm a meaningful uptrend. Holding below this MA, the phase of downtrend is likely to persist.”
In their latest FX Snapshot on September 25, analysts at Citibank Hong Kong said:
"Citi Analysts’ long held view has been the GBP is an eventual sell, but that clearer evidence of both a slowing economy and inflation trajectory were needed for this to come to fruition. This is slowly becoming clearer, with cracks appearing in the labour market despite still strong wages pressures. The BoE are likely to pivot reasonably quickly once growth begins to soften. Current account dynamics and poor investment and productivity trends suggest GBP may underperform EUR medium term.”
Citi’s 3-month pound to dollar forecast was surprisingly bullish, considering the current rate of $1.2183, placing the GBP/USD exchange rate at a potential average of $1.26. The 6-to-12-month forecast, however, was bearish, suggesting that the pound to dollar rate could drop to $1.19, according to the bank.
The bank's long-term cable outlook was bullish, projecting the GBP/USD pair to recover and trade at a potential average of $1.40.
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