GBP/USD: Dollar Jumps As Fed Scales Back Rate Cut Rhetoric

The pound moved steadily lower versus the dollar on Tuesday. The pound US dollar declined to a nadir of US$1.2665 overnight as the UK Conservative leadership battle and Fed speakers grabbed the limelight.

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 came under pressure as Boris Johnson and Jeremy Hunt continued on the campaign trail for Conservative leader. Boris Johnson shed more light on his plan to leave the EU on 31st October. He said that there were three options. Firstly, a renegotiated deal with the EU. However, the EU have made it more than clear that the Brexit deal will not be renegotiated. The second option would involve the use of article 24 of the World Trade Treaty which would ensure that trade continues unhindered. However, the World Trade Organization have said Article 24 would not apply. This leaves the third option which is a no deal Brexit.

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.

The only reason that the pound didn’t drop lower was because opposition to Boris is growing. Over 10 Conservative MP’s have said that they will join Labour for a vote of no confidence against the new Prime Minister in the scenario of a no deal Brexit. Given that a new Prime Minister would have a working majority of just 3, a general election could happen as soon as September. Whilst this would prevent a no deal Brexit, it would create further political uncertainty, which is neither good for UK businesses, the economy or the pound.

Today investors will keep an eye on Mark Carney as he speaks with other central bank policy makers. Any hints that the UK could adopt a more cautious tone could send the pound lower.

Dollar Rallies On Reduced Cut Expectations

The dollar experienced a late rally on Tuesday as Federal Reserve officials lowered market expectations for a rate cut. Following the last Federal Reserve monetary policy meeting last week, market participants increased expectations of a rate cut, possibly as soon as July. However last night the Fed pushed back on these expectations.

Fed officials, James Bullard, Fed Chair Jerome Powell and Thomas Barkin all reigned in their dovish tone. As rate cut expectations declined, the value of the dollar increased.

Why do interest rate cuts drag on 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. Lower interest rate environments tend to offer lower yields. So, if the interest rate or at least the interest rate expectation of a country is relatively lower compared to another, then foreign investors look to pull their capital out and invest elsewhere. Large corporations and investors sell out of local currency to invest elsewhere. More local currency is available as the demand of that currency declines, dragging the value lower.

Today investors will be watching a raft of US economic data. The most closely watched will be durable goods. Strong durable goods figures could lift the dollar higher as strong sales points to a confident consumers, happy to spend.

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