GBP/USD hits new post-Brexit high as dollar extends drop

The big news today is that the dollar's losses have sharply accelerated, but without any fresh news. The economic calendar is light and US stock markets will be closed in observance of Martin Luther King Day. This hasn't stopped the Dow futures from melting up another 140 points. It goes to show that in low-volume days like today, it is even harder to resist against a strong trend. The markets simply drift in the trend direction as resting stop orders above (in the case of stock indices) or below the market (in the case of the dollar), attract prices towards them. In dollar's slipstream, the GBP/USD has hit a new post-Brexit high of 1.3800, the EUR/USD has neared the 1.2300 handle while the USD/JPY has sunk towards 110.50. With the dollar down, buck-denominated gold and silver have both rallied, once again ignoring the gains in US stock index futures. For much of last year, the historic negative correlation between US indices and gold was non-existent, and that relationship – or lack thereof – has continued into the New Year.

So, why is the dollar falling?

I think it is because of the fact that global inflation is on the rise. Now you might be wondering what I am on about: after all, if inflation is rising, you would expect the Fed to respond by raising interest rates, and that surely would be dollar-positive. Yes, that's true, but the fact is the Fed won't be the only central bank that would need to raise interest rates if global inflation is rising. In fact, central banks who haven't yet tightened their belts, like the ECB, might have to do so more aggressively than the Fed, for there's a greater risk of overcooking inflation in regions where interest rates are still at, below or near zero. So, the dollar may be falling only because of expectations that the Fed will tighten its monetary policy at a slower pace relative to some other major central banks. It is also worth noting that the Fed's recent hikes had been priced in by the time they occurred. So it could be that the Fed's next couple of rate hikes are also mostly priced in.

In addition to the above, the euro and the pound in particular, have been supported by favourable political backdrop in Europe. Angela Merkel is moving nearer a grand coalition in Germany, while expectations of a hard Brexit have diminished considerably in recent weeks. So, sentiment towards the likes of the GBP/USD and EUR/USD is turning positive by the day and this is pressuring the dollar.

GBP/USD approaching significant technical levels

For now the long-term technical outlook on the GBP/USD looks constructive, although it is approaching some key hurdles. As can be seen from the weekly chart, below, the cable managed to break above its long-term bearish trend line in November, which basically ended any remaining bearish hopes. In December, the re-test of the now broken trend line offered support, confirming the buyers are in control. The GBP/USD subsequently moved decisively above the key 1.3505 level, which was the 2009 low. And last week, it broke above its 2017 high of 1.3650, too. Thus, going forward 1.3650 and 1.3505 are the key levels that the bulls will need to defend. If they fail to do so and price subsequently breaks the last low prior to the latest rally at 1.3300 then this would mark the end of the uptrend. But for now the uptrend remains intact and as such we could see further gains before price potentially turns. They next key level of resistance to watch comes in at 1.3835/50 area. As well an old support, this is where the 61.8% Fibonacci retracement level also comes into play. Beyond this, 1.4000/15 is the next bullish objective. This psychologically-important hurdle was the last low hit just before Brexit. Once support, this could potentially turn into a long-term resistance level.