The pound started the week on a positive note, but the bulls couldn't have full control of 1.2300. It has a chance to rise in the coming days and the UK has a favorable domestic picture. The Federal Reserve and the dollar will be decisive. What should short-term traders prepare for?
The pound rose against the dollar and other currencies as the dollar continues to be sold after last week's release of the US inflation report. The Fed got a signal on the approaching victory over rising prices in the country, but it is still unclear how the new data was really interpreted. We'll find out in the next meeting..
Meanwhile, the recent easing of financial conditions, as noted by analysts, could trigger the Fed's reaction to quantitative tightening, which will be a potential risk for the pound in the next few weeks.
It is also worth noting that GBP/USD has now reached its growth ceiling, it needs more factors to recover further. The technical picture also looks debatable, the pound has serious resistances near 1.2302 and 1.2382 ahead, which will be difficult to overcome.
That's not even a question. It would be hard for the sterling to budge if the dollar enters a bullish correction. Furthermore, pound bulls have to struggle for the 1.2200 mark so that GBP wouldn't fall lower, and there are risks involved.
"Over time, the situation is likely to return to a more neutral or supportive direction for the dollar. The resilience of the U.S. economy is becoming more evident, the balance of risks is still tilted toward more Fed rate hikes rather than cuts estimated in the second half of the year," commented Goldman Sachs.
Fundamentals, on the other hand, support the recent shift in the dollar, and that seems likely to continue in the near term. If the dollar does enter a bullish correction, it will not be a strong one. There are pressure factors for the dollar, a resurgence in the Chinese economy and a warm winter in Europe that has smoothed out the risks of an energy crisis in the region.
A hawkish European Central Bank and change in the Bank of Japan's positions also play against the US dollar. All of these additional downside risks could potentially benefit the pound in the short term.
No matter what anyone says, the downtrend in U.S. inflation means that the FOMC is not far off from completing its rate hike campaign. The market has started to lay down for a rate easing cycle, which leads to lower yields on 2-year and 10-year Treasuries and puts pressure on the dollar.
A new headache for the dollar
On Wednesday, the focus will be on the US retail sales report. Analysts are widely expected to clarify the picture. Higher interest rates are holding back demand and this should be reflected in the fresh data. If the economists' consensus is correct, there will be a further drop in sales in December.
Falling retail sales will likely weigh on the dollar. But the weakening financial conditions as evidenced by the falling dollar, falling bond yields and rising stock markets are both a growing problem and a great opportunity for the Fed.
The problem is that they undermine and neutralize the effect of raising rates. Speaking of a great opportunity, it is worth noting here that the central bank is seeking to reduce its balance sheet through additional tightening in the coming months.
Fed members continue to convince markets that they will do more in the future to reduce the balance sheet, which has been bloated by bond purchases during the pandemic.
To the extent that the US central bank plans to respond to excess demand in the bond market, there could be downside risks to GBP/USD. January will end soon, and the central bank will announce its next monetary policy decision on February 1.
The dollar is trying to stabilize on Tuesday amid cautious markets. The U.S. currency index is expected to trade in a 102.00-102.50 range during the session, according to economists at ING.
"The dollar itself is stable. Activity in the U.S. data calendar begins Wednesday with the December retail sales release. Its results may be weak. Therefore, further consolidation of the indicator is likely today. Tomorrow in Asia there might be a bearish breakthrough if the Bank of Japan decides again to adjust the target level of 10-year government bond yields," economists comment.
British positive
The pound's recovery against the dollar could potentially be stimulated by employment and inflation data.
The economy added more jobs than expected, while wages grew faster. The unemployment rate was unchanged at 3.7%. Jobless claims rose 19,700, just below the consensus of 19,800.
In order for the Bank of England to start to consider withdrawing its high interest rate policy, wages and employment would need to fall, as this would be a sign of a cooling economy.
So far, the statistics are consistent with another 50bp rate hike in Britain. The pound was supported by the labor market data.
GBP/USD was above 1.2200 after the report.
Despite the optimism of pound bulls, a convincing move above the 1.2300 level looks unlikely. On Tuesday, the pound will trade in a range between 1.2160 and 1.2260, the UOB believes. It is certain that the upward movement will continue. This, in particular, was seen on Monday, but bulls were unsuccessful and they had to go back.
For the next three weeks analysts have a positive view on the pound.
Support is located at 1.2165, 1.2110 and 1.2065. Resistance is at 1.2265, 1.2305, 1.2360.