GBP/USD bulls need the BoE to throw a hawkish lifeline

GBP/USD is currently trading at 1.3924 and down around 0.4% in the afternoon New York session attempting to correct the steep bearish decline. 

Cable has traded between a high of 1.4008 and a low of 1.3895 on the day so far, reeling in the wake of US dollar strength. 

GBP took back a little ground vs the G10s earlier in the week on the release of the stronger than expected UK Consumer Price Index data with sufficient strength in the release to spark a little more interest in the Bank of England’s next policy meeting on June 24.  

However, that was before the Federal Reserve came along and took the markets by surprise with a hawkish hold.

The hawkish tone from yesterday's meeting and dot plot that now shows a faster-than-expected pace of tightening weighed on risk sentiment and sent US yields and the greenback higher.  

Fed Chair Powell described this week's meeting as the 'talking about talking about' meeting.

Markets took this as a sign that members are now seeking a plan to reduce the pace of QE while they're bringing forward their projections from flat to +50bp in rate hikes by end-2023.

The combination has continued to percolate through markets with knee jerk reactions in the dollar extending into today's trade despite the bullish data overnight from New Zealand and Australia. 

The DXY has powered ahead is trading at the highest since April 13, taking on the 92 level with a high after easily breaking above the 200-day moving average near 91.538.  

Bulls now have sights on a test of the March 31 high near 93.437.  

However, is the Fed really that close to hiking and has the market overshot?

The market has been building US dollar shorts for a considerable time and the volatility on forex has been at its lowest in over a year for just as long. 

There is a lot of pent up demand in the markets and traders are seeking to survive on more than just the carry.

In the opinion of analysts at Brown Brothers Harriman, the Fed is not close to hiking, ''but it is moving closer.''

''Of note, there was no language in the official statement about tapering.  In terms of updated forecasts, Fed sees core PCE at 3.0% this year vs. 2.2% back in March, 2.1% in 2022 vs. 2.0% in March, and 2.1% in 2023 vs. 2.1% in March. 

Lastly, the Fed raised the IOER by 5 bp to 0.15% but this was a purely technical move to help move effective Fed Funds off the zero bound in the face of ultra-abundant liquidity.''

''Powell noted that the Fed will continue to assess progress towards its dual mandate in coming meetings but that it’s “still a ways off.”  If his outlook is to be believed, that time is not as far off as the market thought,'' the analysts also explained. 

Importantly, the analysts also noted that the 10-year breakeven inflation rates are down 6 bp on the hawkish hold.  

''That is, the market has even more confidence that the Fed won't let inflation get out of hand.  With the 10-year yield up 7 bp, the real yield has risen 14 bp to -0.76%, the highest since April 19.  

This is dollar-positive and we think there's room to go even higher.''

All eyes on the BoE

Meanwhile, as for the pound, market participants appear to be comfortable in the view that much of the inflation experienced this year in the UK will have a transient nature.

However, there is significant uncertainty around the length of time current supply bottlenecks will take to dissipate, analysts at Rabobank said. 

''This uncertainty has given way to the debate as to whether inflation expectations will be impacted and whether price pressures in the forthcoming economic cycle could be higher than in recent history.''

''In the UK, the inflationary argument is made all the more interesting by reports that Labour supply could be diminished as a consequence of the confluence of Brexit and the pandemic.''

The analysts argued that could have the potential to impact wage inflation in the UK. 

Following the CPI print, this makes for the next labour market report and BoE meeting an important set of events, especially given the shift the Fed for which policymakers will be paying close attention. 

At the end of last month, the MPC’s Vlieghe did suggest that a rate hike was possible in the first half of next year if the job markets bounce backs.  

GBP bulls will be looking for any less dovish takeaways from the Bank next week.

On the other hand, ''we see current headwinds for the pound in the shape of the delayed re-opening of England’s economy and potentially as a result of tensions with the EU over the Northern Ireland protocol which have raised the threat of a trade war,'' the analysts at Rabobank warned. 

GBP/USD technical analysis

Techcnailly, analysts BBH said that sterling needs to break below $1.3890 to set up a test of the April 12 low near $1.3670.