Dollar Faces Mounting Pressure Despite Safe Haven Flows Amid Fed Rate Cut Expectations

Global FX traders are increasingly adopting bearish dollar strategies ahead of the September Federal Reserve (Fed) rate decision. Although recent risk aversion, fuelled by concerns over the AI sector and rising geopolitical tensions, has driven safe haven flows into the US currency, cushioning its decline, the dollar index remains on track for its worst month of 2024. This trend persists despite a modest rebound from 1-year lows, as growing signals suggest the Fed will cut rates in September. Meanwhile, US consumer confidence improved in August, with the index rising to 103.3 from 101.9, beating forecasts of 100.7. However, despite this six-month high, the labour market differential reading fell to its lowest level since March 2021. 

Concerns over the US labour market have overshadowed the narrative, but traders are still betting on a 25 or 50 basis point rate cut in September, with up to four 25 basis point cuts by year-end.

Pound Surges to Two-Year High as Bullish Sentiment Grows Amid Diverging Rate Expectations

The pound has surged beyond $1.32 against the US dollar, reaching its highest level in over two years. Options traders are increasingly bullish on the currency’s prospects for the next month, marking the most optimistic outlook since 2020. This sentiment is driven by a growing belief that the Federal Reserve (Fed) will cut interest rates more aggressively than the Bank of England (BoE).

Although the BoE has already reduced rates this year from 5.25% to 5.00%, market expectations indicate that the Fed will ease more rapidly. Currently, markets are pricing in around five basis points of easing from the BoE next month, compared to about 30 basis points for the Fed. For the rest of the year, the BoE is expected to cut less than 40 basis points, while the Fed is anticipated to reduce rates by 100 basis points. Reflecting this outlook, options traders have become increasingly bullish on the pound, with one-month risk reversals showing the largest spread in favour of sterling since the start of the pandemic.

BoE Governor Andrew Bailey has cautioned that monetary policy will need to remain restrictive for an extended period, indicating that the easing cycle will be gradual. His remarks suggest a sustained divergence between US and UK rates, which is likely to continue supporting sterling.

European Markets Stagnate Amid Thin Trading; Euro Faces Pressure Ahead of Key Inflation Data

Tuesday saw little movement across European markets, with trading volumes remaining thin. Equity markets ended the day largely unchanged, and bond yields showed minimal variation. However, the broader Euro index closed in the red as concerns over weakening domestic fundamentals grew, while the EUR/USD pair edged down to $1.116 as month-end flows influenced the forex market. The euro's recent rally above $1.12 may have peaked, with technical indicators pointing to a potential pullback.

Investors are becoming increasingly cautious ahead of Friday’s release of Eurozone inflation data for August, which could significantly impact the European Central Bank's (ECB) monetary policy. Inflation in Germany and the wider Eurozone is expected to drop to its lowest level in over three years. Despite ECB officials signalling a cautious approach to rate cuts, markets are still pricing in about 65 basis points of cuts by year-end.

Meanwhile, the EUR/CHF pair fell nearly 0.5%, hitting a three-week low due to safe-haven outflows. In France, political tensions resurfaced as President Macron faced difficulties in forming a new government. After four days of discussions with party leaders, Macron ruled out forming a government with the left-wing Nouveau Front Populaire (NFP) alliance, citing the need for “institutional stability.” If a new government isn’t formed, a budget led by caretaker PM Gabriel Attal could result in €10 billion in cuts, which falls short of Brussels’ expectations. This uncertainty widened the OAT-Bund 10-year spread to 73 basis points, up 2 basis points from the previous day, adding further pressure on the euro.

Pound Sterling has maintained its positive momentum due to constructive market sentiment and contrasting speeches from Andrew Bailey and Jerome Powell on Friday. However, we anticipate that further outperformance will be more muted in the near term. Bank of England Governor Andrew Bailey’s remarks that it is “too early to declare victory” over inflation have supported market expectations that the Bank will skip another rate cut in September. In contrast, both the European Central Bank and the Federal Reserve are expected to cut rates in September, with potential further cuts before year-end. This slower path of cuts from the Bank of England provides fundamental support for the Pound against both the Euro and Dollar.

Constructive global market sentiment has been another key driver behind the Pound’s recent outperformance. Friday’s jump in stocks propelled the UK currency to new highs against the Dollar and bolstered its recovery against the Euro. The Pound to Euro exchange rate rose above 1.18, while the Pound to Dollar pairing reached 1.32. Over a one-week period, the Pound has been the best-performing G10 currency and remains 2024’s best performer. However, Monday saw markets give back some recent gains, particularly against the U.S. Dollar, due to losses centred on the U.S. technology sector ahead of Nvidia’s midweek results announcement.

Disappointment in Nvidia’s performance could bolster the Dollar from recent levels, but we do not see this significantly impacting Pound exchange rates. Pullbacks in GBP/USD are likely to be shallow as long as the market expects the Federal Reserve to deliver several interest rate cuts in the coming months. Looking ahead, we expect the Pound’s outperformance to be more muted, with GBP/USD potentially capped at 1.32 in the near term. The exchange rate has become overbought in the short term, and some unwinding is necessary. Monday’s losses in GBP/USD linked to the U.S. tech sector selloff suggest a broader market pullback will temporarily weigh on the UK currency.

Meanwhile, GBP/EUR is now in its fifth daily advance, which is unusual for this exchange rate. GBP/EUR is a slow mover with a mean-reverting tendency, and some softening is possible if global markets face a setback. We will be watching inflation data from the Eurozone this week, with Germany’s data on Thursday and all-Eurozone data on Friday. Any undershoot in these data could potentially boost expectations for ECB rate cuts, which would, in turn, weigh on the Euro.

GBP Faces Pullback Amid US Yield Rebound but Remains Buoyant on Strong UK PMI Data

GBP has slightly retreated from its over 1-year highs against the USD following a rebound in US yields, spurred by robust PMI figures. Despite this pullback, GBP/USD managed to extend beyond $1.31, supported by better-than-expected UK PMI data, which indicates continued economic recovery in Britain.

Preliminary August services data rose to 53.3, surpassing the 52.8 forecast, marking the tenth consecutive month of growth. The manufacturing sector also showed expansion at 52.5, beating estimates and suggesting a more balanced recovery. Further analysis of the surveys revealed rising business activity and resilient demand, leading to the fastest employment growth since June 2023. Additionally, inflationary pressures eased across the private sector, with input costs increasing at the slowest rate since January 2021. This could give the Bank of England more confidence to consider another interest rate cut in November, although a September cut appears unlikely, while markets are anticipating rate cuts from both the Fed and ECB. This has bolstered demand for GBP

Powell's Upcoming Jackson Hole Speech Could Shape Market Expectations and Dollar Trends

Fed Chairman Jerome Powell is set to speak at the Jackson Hole Economic Symposium today, where he will provide insights into the central bank's potential response to growing indications of a moderating job market. This speech could be a crucial moment for market participants, influencing whether the current expectations of easing are warranted and determining the future direction of the dollar's downtrend.  A less-dovish speech by Powell today, which could strengthen the dollar and temper the risk rally. 

British Pound Surges to New 2024 High as Weak U.S. Labour Data Fuels Dollar Decline

GBP surged to a new high for 2024 against the USD after data revealed that the U.S. labour market was weaker than previously estimated, likely prompting the Federal Reserve to take action. The Pound-to-Dollar exchange rate climbed to 1.31 after the Bureau of Labour Statistics admitted it had overestimated job creation by 818,000 in the 12 months leading up to March 2024.

This boost pushed the best rate for international transfers above 1.3050, giving UK buyers of USDs their most favourable exchange rate since July 2023. The USD weakened across the board following the data release, as market expectations for Federal Reserve rate hikes increased. The Fed has indicated that it is closely monitoring labour market softness when considering potential rate cuts.

Before the data was released, the GBP/USD exchange rate had been struggling to break through a technical resistance around 1.30-1.3040. However, the new data and the subsequent market response might lead to a more decisive upward movement in the exchange rate. The market's reaction to the BLS payroll revision has caught many by surprise, as such revisions have typically gone unnoticed in recent years.

Strong UK Economic Outlook

GBP continues its upward momentum against most major currencies, buoyed by a risk-on sentiment in the markets. Investors are optimistic about the increasing likelihood of further monetary easing by the Federal Reserve following dovish minutes released yesterday. Today's focus is on the flash PMIs, which are expected to show that the UK economy remains strong in 2024.

GBP/USD is trading at its highest level in over a year, maintaining a bullish tone with a sustained break above its 200-week moving average. The pair has risen in 10 of the last 11 trading sessions and is hovering near $1.31—a level it has surpassed only four times in the past 522 trading days. FX options pricing suggests a 40% implied probability that GBP/USD will be above $1.32 by year-end, compared to a 25% chance of it falling below $1.28. However, the relative strength index (RSI) indicates overbought conditions, which could lead to a short-term pullback or consolidation.

Rate differentials continue to favour the Pound, with money markets anticipating fewer than two rate cuts by the Bank of England by year-end, compared to four expected from the Fed and three from the ECB. The Jackson Hole symposium, starting today, will offer further insights into the global monetary policy outlook as traders closely watch upcoming speeches by central bankers.