The pound is the worst performer out of the major currencies versus the USD so far this year. We may only be 8 days in, but GBPUSD is already down more than 3%. The pound is doing significantly worse than the EUR and the commodity currencies that have been battered by the fall in the oil price. Even the Russian ruble is outperforming poor old sterling.
Earlier this week we mentioned that there was a perfect storm for sterling right now including disappointing economic data, the decline in the oil price weighing on inflation prospects and political uncertainty. We also focused on the interest rate differential. We said that the difference between UK rates and US rates was at an extreme level, which was one factor weighing on the pound (low yields matter for FX as higher yields tend to be good news for currencies and vice versa).
However, on Thursday the yield differential, which had fallen to its lowest level since 2006, started to narrow (see the chart below), yet the pound continued to fall, reaching an intra-day low of 1.5035.
Does the yield differential really matter?
The short answer is absolutely. Even though the UK-US differential may have narrowed from -41 basis points to -37 basis points, it is still very low by historic standards and may not be enough to sustain a reversal in the pound. Added to this, the USD seems to have broken free from the nominal level of US Treasury yields.
Since peaking in December, the 2-year Treasury yield has fallen more than 13 basis points, while the 10-year yield has been falling for most of the last 12 months. Thus, as long as US yields hold a sizeable advantage over their peers, then this seems to be good enough for dollar bulls.
Payrolls, the next major driver of GBPUSD
The next major driver of yields and the USD will be payrolls on Friday. Another larger than expected reading for NFPs (the market currently expects 230k) could trigger another leg higher for the US dollar and a break of 1.50 for GBPUSD cannot be ruled out.
GBPUSD: the technical view
From a technical perspective, momentum is still to the downside, and this pair appears to be making its way down to strong support at 1.4814 – the low from July 2013. Any short-term rally may be faded by the market as the FX world seems reluctant to cut the pound some slack at this stage. In the short term, key resistance lies at 1.51256 – Wednesday’s high – and then 1.5274 – the high from Tuesday.
Our bearish view on the pound would change if:
1) we get much weaker than expected payrolls on Friday or
2) The UK – US yield spread surges by 20+ basis points in one day.
For now, momentum is to the downside, the yield spread may be taking a breather but it remains GBP negative. The next 24 hours will be critical for GBPUSD. If the US NFP report is another strong one then we could see further declines for the pound and a move below 1.50, while a weaker NFP report could trigger a reversal.
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