The pound continued to sink versus the dollar on Wednesday. The pound US dollar exchange rate fell to a fresh 4 month low of US$1.2624.
|What do these figures mean?|
|When measuring the value of a pair of currencies, one set equals 1 unit and the other shows the current equivalent. As the market moves, the amount will vary from minute to minute.For example, it could be written:1 GBP = 1.28934 USDHere, £1 is equivalent to approximately $1.29. This specifically measures the pound’s worth against the dollar. If the US dollar amount increases in this pairing, it’s positive for the pound. Or, if you were looking at it the other way around:1 USD = 0.77786 GBPIn this example, $1 is equivalent to approximately £0.78. This measures the US dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the dollar.|
The pound dived as fears of a no deal Brexit haunt traders. UK Prime Minister Theresa May is clinging to power by a thread. Rumours are circulating that she could hand in her resignation any day as her cabinet desert her. The pound has fallen for a record 13 days as pound traders brace themselves for a pro-Brexit replacement. Should a pro- Brexit candidate replace Theresa May, the possibility of a no deal Brexit increases significantly. A no deal Brexit, according to economists is the worst-case scenario for the pound.
|Why is a “soft” Brexit better for sterling than a “hard” Brexit?|
|A soft Brexit implies anything less than UK’s complete withdrawal from the EU. For example, it could mean the UK retains some form of membership to the European Union single market in exchange for some free movement of people, i.e. immigration. This is considered more positive than a “hard” Brexit, which is a full severance from the EU. The reason “soft” is considered more pound-friendly is because the economic impact would be lower. If there is less negative impact on the economy, foreign investors will continue to invest in the UK. As investment requires local currency, this increased demand for the pound then boosts its value.|
Attention today will swing towards the European Parliamentary elections. The polls show that the Brexit party is ahead with 37% of the votes, whilst the UK Conservatives have just 7% support. A solid win by the Brexit party could embolden the Conservatives to favour a pro-Brexit leader.
The dollar barely flinched on the release of the minutes from the Federal Reserve monetary policy meeting, the FOMC, in May. As market participants had expected the Fed confirmed their neutral approach. The minutes showed that the Fed were not looking to cut rates, and that they believed that softer inflations in the US was transitory. The minutes also revealed that the Fed was in no rush to raise rates either. The neutral tone meant that dollar traders didn’t change their future expectations for rate rises.
|Why do raised interest rates boost a currency’s value?|
|Interest rates are key to understanding exchange rate movements. Those who have large sums of money to invest want the highest return on their investments. Higher interest rate environments tend to offer higher yields. So, if the interest rate or at least the interest rate expectation of a country is relatively higher compared to another, then it attracts more foreign capital investment. Large corporations and investors need local currency to invest. More local currency used then boosts the demand of that currency, pushing the value higher.|
The minutes are from a meeting in early May, just prior to the most recent escalation of the US — China trade war. The geopolitical landscape has changed since then.
The dollar is moving higher again as investors continue digesting developments in the US — China trade dispute. Reports that the US is considering implementing Huawei sanctions on another Chinese technology firm is sending jitters across the markets. Investors fear that the trade dispute is turning into a full blown, prolonged trade war. Given the increase in geopolitical tensions, investors are buying into the dollar for its safe haven properties.
Today there is plenty of US data for dollar investors to digest. Initial jobless claims, home sales and pmi data will help investors see how the US economy is holding up.
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