Recovering Stock Markets Hoist Pound Sterling From Lows against the Euro and Dollar

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  • Market rates at publication: GBP/EUR: 1.1668 | GBP/USD: 1.3898
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The British Pound on Monday recovered some of the sizeable losses experienced the week prior, helped in part by an improved sentiment amongst bruised investors.

The Pound is considered a 'pro cyclical' currency as it is often subject to global investor sentiment, tending to rise when equity markets are going up, and fall when the opposite is true.

The Pound and markets fell through the latter half of the previous week as investors sold on fears the Federal Reserve was moving to withdraw the trough of 'easy money' they have provided since the outset of the Covid-19 crisis.

But some improvements in sentiment is seen on Monday and this is aiding Sterling,

"G10 FX markets are starting to show some signs of stabilization as risk appetite improves, but we think it is still a little early to sound the all-clear. So far, we think the bulk of the move has been driven by a liquidation of stale USD shorts," says Ned Rumpeltin, European Head of FX Strategy at TD Securities.

"Those looking to fade recent moves may consider tactical NOK, AUD and NZD longs while GBP and CAD still look a little vulnerable at current levels," he adds.

Forecasts issued by the Fed last week showed the timing of the next interest rate rise would likely be in 2023, whereas the previous set of forecasts showed this date to have been 2024.

Stocks fell and the Dollar rallied as markets saw 'tighter' monetary conditions coming into view.

"The combination of a surprisingly-exciting Fed meeting and options expiry on Friday meant that many markets were dramatically shaken out of their complacency, with the Dow, gold and key FX pairs seeing sharp drops," says Chris Beauchamp, Chief Market Analyst at IG.

The below chart shows that the Pound's pro-cyclical credentials as GBP/USD tends to track global investor sentiment, here expressed by performance in the S&P 500 index:

Pound tracks risk sentiment as per the S&P 500

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The new week sees some stabilisation in sentiment with markets rising, giving the Pound a hand higher.

"The Pound also generally performs well in a pro-cyclical market environment, so may benefit from global rather than domestic tailwinds," says Zach Pandl, an economist at Goldman Sachs.

The Pound-to-Dollar exchange rate (GBP/USD) rose 0.70% day-on-day to quote at 1.3898 at the time of writing; the previous week's high is at 1.4124.

The Pound-to-Euro exchange rate (GBP/EUR) rose 0.30% day-on-day to quote at 1.1666; the previous week's high is at 1.17.

"The UK pound steadied after it extended its Fed-inspired slide to two-month lows against the greenback. Central banks loom large for GBP/USD this week with Fed official speaking every day, while the Bank of England releases a policy statement Thursday," says Joe Manimbo, Senior Market Analyst with Western Union.

While the markets appear to have stabilised somewhat IG's Beauchamp warns "there is a long way to go before we can be certain that the previously-quiet atmosphere of 2021 has reasserted itself".

Rumpeltin at TD Securities says some caution is still warranted as volatility could extend a bit further.

He says any attempt at a rally in stock markets is going to struggle given the lack of news, and for the FTSE 100 some dollar weakness would be good to lift mining stocks from their current poor run.

"Rising instances of the Delta variant in Europe will likely weigh on European markets, but the overall view continues to be that the second half of the year will see a further return to normality, boosting earnings in the medium term," says Beauchamp.

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GBP/USD Forecasts 2021

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However, analysts at Morgan Stanley have this week told clients they see the potential for the further Dollar strength as a the previous week's Federal Reserve meeting prompts a broader regime shift in sentiment.

"A more hawkish Fed likely sees an important regime shift that brings higher real yields and USD strength," says James K Lord, Global Head of FXEM Strategy at Morgan Stanley.

How any 'regime shift' impacts stock markets going forward will be key for the Pound if it is to maintain a 'pro cyclical' status and track global investor trends.

"A few weeks ago, we had already dipped our toes into long USD positions , but the recent shift in the FOMC's rhetoric increases our conviction as markets shift out of Goldilocks into a higher real yield environment," says Lord.

Morgan Stanley say the market is witnessing the beginning of the U.S. monetary policy normalisation cycle as the US recovery has been much more rapid and the cycle more advanced than the rest of the world since the beginning of the year.

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