GBP/USD bears are lurking around what could be the peak of the bullish cycle

GBP/USD is 0.2% higher at the time of writing on the first day of the week. However, the Pound Sterling is essentially consolidating a move from the potential peak of the current bullish cycle that met highs in the 1.2450s ahead of the Federal Reserve (Fed) and Bank of England (BoE) interest rate decisions last week. GBP/USD has since tumbled to a 1.2120 structure low and on Monday it has travelled between a low of 1.2168 and a high of 1.2241 so far.

Overall, the US Dollar has been softer over the last two full trading days due to an improved appetite for risk despite the prospects of recessions and higher interest rates to be set by hawkish central banks.  World stocks have steadied near six-week lows on Monday after the Federal Reserve maintained a hawkish outlook on interest rates at the December Federal Open Market Committee (FOMC) meeting, pushing the outlook that rates could remain firmer for longer.

US Treasury Yields creep higher following Federal Reserve hawkish hike

US Treasury bond yields have crept higher since the lows that were set in the volatility around the meeting with investors still mindful of interest rate hike risks in 2023. The 1ember-year Treasury yield rose from 3.248% post-Fed lows to a high of 3.601% on Monday.  The 10-year Treasury yields are above an almost three-month low of 3.402% on December 7, but are holding well below the 15-year high of 4.338% reached on October 21 as US Treasury bond investors price in less aggressive rate increases than Fed officials are signalling. After rising as high as 5.5% after the meeting, the terminal rate as seen by the swaps market has fallen back to just below 5.0%. Fed funds futures traders are pricing for a peak rate of around 4.85% in May and a gradual decline to 4.39% by year-end.

However, the yield curve between two-year and 10-year notes remains strongly;y inverted a minus 66 basis points. This indicates investor concerns about a recession in the next one-to-two years. Historically, recession fears and the contagion of such has been supportive of the safe haven US Dollar. In recent positioning data, it was seen that speculators’ net long USD index positions ticked a little higher as well.

US Dollar surprisingly weak

Nevertheless, the US Dollar in the spot market, as measured by the DXY index against a basket of currencies, is lower by 0.35 at the time of writing, but off the lows of 104.13 for the day so far. In this regard, analysts at Brown Brothers Harriman said, ''we cannot understand why the market continues to fight the Fed,.''

''With the exception of some communications missteps here and there, Federal Reserve chairman Jerome Powell and company have been resolute about the need to take rates higher for longer,'' the analysts noted. ''After the decision, several Fed officials confirmed this message. ''

With regards to the latest Dot Plots, the analysts noted that Federal Reserve's John Williams said “it could be higher than what we’ve written down.”  Elsewhere, the analysts noted Mary Daly saying “we still have a long way to go. We are far away from our price stability goal.” 

Although the media embargo has been lifted, there are no Fed speakers scheduled this week. Overall, it has been a tug-of-war between signs of economic softness which could translate to a dovish pivot from the Federal Reserve vs. warnings that restrictive interest rates will rise higher and last longer than many might have hoped. Nevertheless, a lack of market catalysts has kept investors largely on the sidelines at the beginning of a likely low-volume, pre-holiday week, leaving GBP/USD in a sideways range so far. 

Bank of England keeps net GBP shorts lower

Domestically,  Pound Sterling continues to be faded on rallies in the aftermath of the Bank of England’s underwhelming 50 bp hike last week. As with recent meetings, the Committee remained divided; 2 MPC members voted for no change, while 1 member voted for an even larger hike of 75bp.  In the accompanying minutes, the outlook for the economy appeared little changed from the November meeting.

The United Kingdom's political backdrop has retained a calmer air since the start of Prime Minister Rishi Sunak’s premiership. However, ''recessionary conditions are prevalent'' analysts at Rabobank warned. ''Strike action is on the rise and a slew of Tories has already indicated they will throw in the towel at the general election rather than face the possibility that the party could be in opposition for some years,'' the analysts argued. 

The BoE minutes suggested that a recession is indeed expected and an even steeper fall in inflation is now seen next year following the government’s announced extension to the energy price cap. 

''With rates now well into restrictive territory, and the UK economy suffering from a combination of weak aggregate demand but still high inflation, we expect the division on the MPC to intensify over the coming months,'' analysts at ABN Amro said, adding: 

''Still, a majority on the MPC is expected to favour further rate hikes at coming meetings, with two 25bp hikes expected at the February and March meetings, and Bank Rate, therefore, expected to peak at 4%. Thereafter, we expect cooling wage growth and further signs of declining inflation expectations to stay in the BoE’s hands. Once inflation really starts to decline significantly in the second half of 2023, and unemployment begins rising, we then expect some modest rate cuts to take place – most likely in Q4.''

As for positioning data, net short GBP speculators’ positions edged lower and are now around half the size of their position in mid-October. 

GBP/USD technical analysis

Zoomed in...

The 4-hour charts show that the Pound Sterling is now on the backside of the bullish trendline support having potentially peaked out within a bullish correction of the prior bear cycle. GBP/USD is now resting on a ledge near 1.2120 and moving in a sideways channel.

As the British Pound continues to coil vs. the US Dollar, (the cause)  a breakout (the effect) would be expected to see the price driven one way or the other by force to test the next level of support at 1.1900 or resistance, 1.2400. Given that the price is below the trendline resistance, as illustrated above, the bias is for a move to 1.1900 which is just under a full 200% measured move of the current coil's range to 1.1880:

However, given the holiday markets, squaring of GBP positions and thinner conditions, price action can be more erratic and that means the price imbalances to the upside, such as to 1.2280, could be mitigated first.

In-the-money short Pound Sterling positions from within the 1.24s could therefore come under heat and weaker hands squeezed, putting pressure into the peak formation: