Pound Continues To Be Dragged Lower By Dimming Yield Expectations

GBP/USD

The Pound continues to see its losses pile up as speculation rises that the European debt crisis is will have a negative impact on the U.K. economy. Indeed, BoE member Adam Posen told U.S. broadcaster National Public Radio Tuesday that "sixty percent of our trade is with the euro area. So we view this as a very real risk.” A rise in the U.K. consumer price index to 3.7% which is well above the central bank’s 3.0% threshold failed to slow bearish momentum. The MPC isn’t expected to raise rates anytime soon following their dovish quarterly inflation report. Indeed, we have seen yield expectations begin to have a greater influence on price action with its correlation surging to 34% from 12% a week ago. Meanwhile, broader risk aversion remains the primary driver of negative GBP/USD sentiment with its relationship strengthening to 50% from 39% a month ago as the issues in Europe continue to spark global concern.

GBP Interest Rate Expectations

Overnight Index Swaps reflect the dimming outlook for U.K. interest rates following the BoE’s quarterly inflation report, as they are now pricing in a mere 29 bps of tightening over the next year. Yield expectations have been in a downward trend as the central bank leaves the door open for additional quantitative easing. Policy makers recently confirmed their willingness to add to their asset purchase program, which needs to be brought to an end before the start of tightening. Therefore, a positive retail sales report may have little impact on sentiment and yield expectations leaving the upcoming public sector net borrowing report as the next potential event risk for the pair. An improvement in the budget deficit could ease concerns that the U.K. could be in line to suffer the same credit rating issues that plagued Greece. Discuss this and trading ideas join the GBP/USD forum.

FOMC Interest Rate Expectations

Fed fund futures continue to point toward the FOMC remaining on hold until at least the end of 2010 as markets continue to price in a 79% chance that rates will remain unchanged through September. It may take a drop in the unemployment rate which rose to 9.9% in April before the central bank considers employing a tightening policy. However, the other catalyst for a rate hike could be soaring inflation which adds importance to this week’s release of April’s consumer price index. Price growth is forecasted to have slightly accelerated to 2.4% from 2.3% the month prior. However, we may need to see inflation top 3.0% before the alarms start ringing at the FOMC given their focus on job growth.

Risk

Stocks erased earlier gains as concerns that the troubles in Europe will begin to have a drag on the global economy. Indeed, the region is the main destination for exports for several countries including the U.K. and China. A ban on naked short selling by Germany raise concerns that there are more issues under the surface that have yet to rear their head. However, we did see the trend line that we identified yesterday show signs of holding which increases its validity. U.S. assets are becoming attractive with the troubles abroad which could provide an underlining level of support leading to a divergence between it and the pair. Discuss this and other fundamental data in the Economics Forum.

 To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com