The GBP/USD has been relatively range bound since the beginning of June and recent weakness has it testing the lower bounds. The sterling continues to find support from rising optimism domestically and abroad as the local and global economies have shown signs of a recovery.
[B]GBP/USD[/B]
The GBP/USD has been relatively range bound since the beginning of June and recent weakness has it testing the lower bounds. The sterling continues to find support from rising optimism domestically and abroad as the local and global economies have shown signs of a recovery. Risk sentiment has been a main driver of price action as it currently explains 41% of volatility. However, we can see that the relationship is showing signs of weakening which could be due to the gaining influence of interest rate expectations as we can see when it was at 15% a month ago.
[B]BoE Interest Rate Expectations[/B]
There has been a sharp decline in BoE interest rate expectations from 126.5 to as low as 66.7 bps over the past month and a half. It is no coincidence that sterling peak when expectations were at their highest and has since slid back to its previous range. The central bank continues to express concerns over tight lending standards and has left the door open for additional quantitative easing and hinted at lowering the deposit rate. The dovish sentiment has eliminated any hope of a rate hike by year’s end and now it widely expected that tightening will begin in mid -2010. The release of the BoE minutes on Wednesday could alter the outlook for future policy action as it will give insight s into the MPC’s thinking.
[B]FOMC Interest Rate Expectations[/B]
Fed funds futures are currently pricing in a 6.5% chance of a rate hike by the end of the year. The dollar has continued to trade on risk sentiment without the threat of tightening from the FOMC. This has added to the influence that equity markets have on the pair which should make it the primary focus for traders. Markets are expecting interest rates to remain unchanged at this week’s policy meeting, but the subsequent statements could alter the outlook for future decisions. We saw today the greenback find support as there are concerns that the Chairman Bernanke could be hawkish in his remarks. If this is the case then we could see bullish dollar sentiment continue.
[B]Risk Appetite[/B]
Stocks have been on an upward trajectory over the past few months which has helped provide support for dollar crosses. The greenback has now become the funding currency and will continue to be inversely impact by demand for risky assets. The relationship hasn’t been as been as strong for the sterling as it has for high yielders, but at 41% it still accounts for a significant amount of volatility. Concerns are growing that valuations may be getting ahead of potential growth as the credit crisis will alter consumer and businesses spending habits going forward. Therefore, we could see equity markets start to give back recent gains which could equal continued sterling weakness.
[I]To discuss this report contact John Rivera, Currency Analyst: <[email protected]>[/I]