The British pound continues to rebound against the US dollar after US Federal Reserve spokesmen reacted to the decline in bonds. The US dollar found little support from rising tensions in the Middle East and fell further from last week's highs after Federal Reserve members helped stem the sell-off in US Treasuries by signaling that enough might have been done by raising rates. The gains of the upward rebound of the GBP/USD currency pair reached the 1.2303 resistance level before settling around the 1.2285 level at the time of writing the analysis.
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The currency pair's gains extended after Federal Reserve Vice Chairman Philip Jefferson said the US central bank could "proceed cautiously" in assessing whether another increase is needed in light of the rise in bond yields. US Treasury yields led to a rout in global bonds, which led to a rise in bond yields, which raised the cost of borrowing not only in the United States but around the world. In theory, this rise in the cost of borrowing restricts spending and helps the US Federal Reserve in its battle against inflation.
Lori Logan, a member of the Federal Open Market Committee (FOMC) and head of the Federal Reserve Bank of Dallas, said, “Higher term insurance premiums lead to higher interest rates at the same rate as the federal funds rate, all other things being equal.” Thus, if term insurance premiums rise, they could do some of the economic cooling work for us, leaving less need for additional loans: and “tightening monetary policy.”
The comments indicate that the US Federal Reserve has taken into account the rise in bond yields and will take into account the tightening associated with credit conditions when forming future monetary policy decisions. In short, the Fed's acknowledgment of recent market developments has reduced the odds of another US interest rate hike in November.
This alleviates the “higher for longer” narrative on US interest rate expectations, which has been instrumental in fueling the dollar’s rise for several weeks. Accordingly, the yield on 10-year US Treasury bonds fell by 16 basis points to 4.64% in response to Logan and Jefferson's comments. Logan's focus on the “term premium” is notable given that economists believe this is the critical driver of the bond sell-off (and the associated yield rise). The term premium is a component of a bond's return and is defined as the compensation investors need to bear the risk of changing interest rates over the life of the bond.
The next challenge facing the US dollar will be the release of Producer Price Index (PPI) inflation figures on Wednesday, which show how price pressures are developing in the country's factories. Price changes here tend to lead to developments in the more important inflation index (CPI). Thursday contains the most important events of the week in the form of the release of the US Consumer Price Index for September. The same themes as Wednesday's PPI release apply here, except that the market impact should be several orders of magnitude greater.
The headline CPI inflation rate in the United States is expected to decline from 0.6% on a monthly basis in August to 0.3% in September. Such a development is consistent with the downward trend in US inflation, which would mean that the Fed is close to ending its interest rate hike cycle, give or take an additional 25 basis points in November. As always, the effect of moving the market will come from a surprise to the upside (+USD) or the downside (-USD).
Technical analysis of the currency pair:
- The price of the GBP/USD currency pair formed lower highs connected to a downtrend line that has remained stable since mid-August.
- The price is testing this resistance area again and may resume selling soon.
- The trend line coincides with the 38.2% Fibonacci retracement level at 1.2306, but a higher pullback could reach the 50% Fibonacci retracement level at 1.2390 or the 61.8% level at 1.2475.
- If any of these levels hold as resistance, GBP/USD could fall to a swing low at 1.2032.
The 100 SMA is below the 200 SMA to confirm that the overall trend remains bearish or that selling is likely to gain momentum rather than reverse. The 200 SMA lines up with the 50% Fibonacci level adding to its strength as a ceiling as well. The stochastic has already reached the overbought zone to indicate exhaustion among buyers, so a shift lower would mean sellers are back. The RSI has more room to rise before reaching the overbought zone, so the correction may continue until that happens. There is not much high-level UK data this week, so GBP/USD may take cues from US economic data and overall market sentiment.
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