PoundSterlingLIVE - The Pound to Dollar exchange rate (GBPUSD) neared a key technical test in the form of the 2023 high ahead of the midweek Federal Reserve policy decision that could result in a potential fresh best being set for the year.
GBPUSD rose to 1.2648 through the midweek session, taking it to its highest level since May 09. It was on this date that the exchange rate touched its highest level since May 2022 at 1.2680.
Pound Sterling is therefore in a bullish configuration against the Dollar and it would likely require the Federal Reserve to spring a surprise if the uptrend is to be broken.
That is not to say the Fed doesn't have the ability to send the GBPUSD pair lower again, thereby confirming a failed test of resistance; it merely suggests that over the coming days, further upside is preferred from a strategic perspective.
What would the Fed do to deliver a near-term setback to the GBPUSD uptrend?
The base-case assumption in the market is for the Fed to forgo another interest rate hike but signal it remains concerned inflation is elevated and therefore further hikes are likely.
Therefore the immediate downside risk for GBPUSD would lie with a surprise rate hike, something TD Securities says is a surprise they are prepared for.
"This week's decision is likely to come down to the wire, but we maintain our long-held view that the Fed will tighten rates by a final 25bp in June to a range of 5.25%-5.50%," says Oscar Munoz, Chief U.S. Macro Strategist at TD Securities.
Under such a scenario TD Securities sees in the region of 0.10% to 0.20% upside for the Dollar, suggesting downside to Pound-Dollar would be relatively subdued.
Nevertheless, the setback could allow for a period of short-term consolidation to evolve across the Dollar complex and ensure GBPUSD is capped below 1.2680.
Should the Fed forgo a rate hike the odds of a July move would likely rise.
"While economic activity indicators have yet to suggest the Fed is on a clear path to 2% inflation, they can afford to gather more data given the accumulation of rate increases and as the risks to the outlook have become more two-sided," says Munoz, who sees a 40% chance the Fed skips.
Under such a scenario there could be a 0.60% contraction in the Dollar, a move if realised, could push the Pound-Dollar to fresh multi-month highs.
As always the tone and the guidance will be important, meaning market reaction will be subject to much nuance.
Should the Fed skip a hike yet signal clearly it remains concerned about inflation and strongly hint at further hikes, the Dollar could in fact end the day higher.
This is the likely market reaction in the event the market is persuaded to put back the time it expects the Fed to begin cutting interest rates again.
"We expect Chair Powell to reiterate that the Fed remains data dependent and that economic data since the May FOMC meeting has not shown convincing signs of slowing. Although the growth moderation resulting from curtailed credit supply should help limit inflation pressures over time, he will also make clear that inflation risks remain elevated," says Munoz.
Munoz's colleague, Mark McCormick (NYSE:MKC), Global Head of FX and EM Strategy at TD Securities, says whether the Fed hikes in June or July (or skips both) the Dollar will remain focused on the near completion of the tightening campaign.
He adds this skews the risks towards a USD pullback in the second half of the year.
An original version of this article can be viewed at Pound Sterling Live
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