The pound managed to counterattack against the U.S. dollar due to weak U.S. inflation statistics. The personal consumption expenditures index slowed down from 4.3% to 3.8% in May. The core indicator also decreased to 4.6% compared to Bloomberg experts' forecast of 4.7%. As a result, Treasury bond yields fell, and GBP/USD quotes went up.
Debt market rates played a key role in the sterling's ascent in June. In the UK, they were rising rapidly due to expectations that the Bank of England would raise borrowing costs to 6.25%, which is 125 basis points higher than the current level. The general perception of high inflation and rates has gone up a few decibels in the UK recently. Economists, financial market representatives, observers, and policymakers expressed their conviction in the need for further monetary policy tightening. By raising the repo rate by 50 basis points to 5%, the BoE pushed all these GBP/USD fans further up.
Unlike the UK, bond yields in other developed countries were falling while prices were rising. This was due to a pause in the Federal Reserve's monetary restriction cycle and disappointing statistics in the Eurozone. As a result, the risks of continued recession in this region increased, and investors started buying safe-haven assets.
Changes in bond prices in different countries:
In my opinion, the most reasonable approach at the moment is to pause the cycle. Imagine a doctor who is unsure of the nature and severity of the illness. He administered a large dose of medication that has not yet taken effect. Caution would prompt him to pause and observe the patient's reaction. If everything is fine, the dose can be doubled. This example can apply not only to the Federal Reserve but also to the Bank of England. Despite the elevated core inflation in the UK, it is caused by a labor supply shortage, including due to Brexit. The theory states that with this nature of inflation, the central bank should not rush to raise rates. It could harm the economy.
The retiring MPC official, Silvana Tenreyro, says the same. She believes there is no need to increase borrowing costs in the UK. She argues that the Bank of England risks reversing if it tightens monetary policy further. In my opinion, she is right. Market expectations for the repo rate to rise to 6.25% are overestimated. And investors will soon realize this, weakening the position of the pound.
In the U.S., on the other hand, the markets downplay the probability of a federal funds rate hike to 5.75% by the end of 2023. Currently, it stands at 35%. There is room for growth for this indicator, as well as for the U.S. dollar. The "hawkish" rhetoric of the FOMC's latest meeting minutes and strong labor market statistics for June will contribute to this.
Technically, on the GBP/USD daily chart, the quotes are still below the fair value at 1.2735, so it makes sense to sell the analyzed pair. The direction is at least towards the lower boundary of the upward trading channel near the 1.255 mark.