Pound-to-Dollar Rate Bats away U.S. Yield Concerns

The U.S. Dollar has shone over recent sessions and has registered gains against both the Euro and Dollar, with investors paying close attention to a rise in the value of U.S. sovereign bond yields.

However, analysts we follow say the Pound remains preferred to the U.S. Dollar and that weakness in the Pound-to-Dollar exchange rate (GBP/USD) will likely be temporary until a marked shift in investor behaviour transpires.

Indeed, as we go to publication the Pound is reminding its feet and is back above 1.39.

Nevertheless, a new risk has popped onto the radar for those with an interest in stock markets and the performance of the Pound: the yield paid on U.S. bonds – particularly those that have an expiry date of ten years – has risen notably because investors are expecting higher inflation rates in the future.

The rising yield simply says investors will want an increase in compensation for holding bonds in an environment of rising inflation.
“Right now, the investor focus is fixated on bond yields which continue to rise due to growing expectations that inflation will be returning as the global economic recovery is expected to speed up,” says Fawad Razaqzada, Market Analyst at ThinkMarkets.

And with U.S. bonds offering higher yields they start looking more attractive to overseas investors, who then enter the market and bid up the value of the Dollar.

The rising Dollar was felt across the market, with the Pound-to-Dollar exchange rate seeing the brakes applied to its rally to go lower to 1.3865.

Thursday trade sees the pair back to 1.3912 with bank transfer rates offered in the bracket of 1.3520-1.3620 and specialist FX transfer providers offering in the bracket of 1.3760-1.3811.

This week’s high is at 1.39502.
“The markets are pricing in a strong recovery once lockdowns end and things start to go back towards normal, as pent-up demand from households and businesses will likely replace government spending and central bank stimulus,” says Razaqzada. “If yields push onwards and upwards from here, then this could put some pressure on the stock markets,”

It could also mean the Dollar finds more demand.

“I think that the scope for the dollar to rise further, and for risk appetite to sour, depends on the speed of any continued rise in yields,” says Michael Brown, Senior Market Analyst at CaxtonFX.

It is however worth pointing out that the Pound-Dollar exchange rate has thus far only experienced moderate weakening in response to rising U.S. yields and, if anything, the trend higher in the exchange rate is keeping pace with the rising yields, as detailed below:
While analyst focus on U.S. yields and what they might mean for stock markets and currencies going forward has risen sharply over the past 48 hours most still say the rise is yet to make a big impact, but that this is something for investors to keep an eye on going forward.

In short, it is a risk on the radar and there could come a point where markets capitulate and the Dollar rallies sharply which could see GBP/USD reverse.

One reason why it might be too soon to expect a marked shift in investor behaviour and trends lies with the Federal Reserve which will in all likelihood fight back against any rapid rise in yields in order to avoid any market meltdowns.

The Fed calmed investor nerves midweek with the release of the minutes of their latest monetary policy meeting held on January 27.

Officials expressed more confidence about economic developments, that the government’s stimulus programs and the Covid-19 vaccines are giving the economy a significant boost.

However, they cautioned it will take some time before “substantial progress” is evident, therefore they will maintain an expansionary stance over the medium term by maintaining record-low interest rates and generous quantitative easing programmes.

As a result the Pound’s uptrend against the Dollar is not being seriously questioned and technical analysts we follow say a test of the 1.40 level remains a high probability event in coming days.