GBP/USD reclaims 1.22 & may look to recover furtherBut Fed’s congressional testimony a risk to GBP/USDUK CPI, PMIs, retail sales, BoE speeches also ahead

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The Pound to Dollar rate rebounded sharply from near March 2020 lows last week and could look to extend its recovery in the days ahead but much depends on U.S. bond yields and the impact of remarks from Federal Reserve (Fed) policymakers as well as a looming flurry of UK economic figures.

Sterling tumbled briefly below 1.20 against the Dollar last week only to rebound as far as 1.24 on the Thursday when the Bank of England (BoE) announced its fifth interest rate rise since December, which was followed by a sharp uplift in market expectations for Bank Rate over the coming months.

But the Pound was also helped significantly when the Dollar softened almost across the board alongside U.S. government bond yields following the June monetary policy decision of the Federal Reserve.

“If inflation fails to cool, the Fed will have to maintain the 75bps pace of tightening into the summer; the June CPI data due, due July 13th and the July U. Michigan inflation expectations data on July 15th are key data reports to monitor,” says Shaun Osborne, chief FX strategist at Scotiabank.

“For now, however, with the Fed looking fully priced and spreads not making new ground in the USD’s favour, the USD may struggle to improve,” Osborne and colleagues also said last week.

Above: Pound to Dollar exchange rate shown at daily intervals with spread or gap between 02-year UK and U.S. government bond yields. Click image for closer inspection.

While the market's increasingly ‘hawkish’ expectations for UK interest rates could yet be discouraged by either the BoE itself or any number of the economic figures set to emerge from the UK this week, they have thus far provided a significant boost to the Pound to Dollar rate.

Rising UK bond yields have combined with the retreat in U.S. yields to lift the spread or gap between those yields in a supportive manner for Sterling after the Fed's June economic projections suggested the bank is likely to lift U.S. interest rates only as far as financial markets had already envisaged for the year.

“This week, the Federal Open Market Committee (FOMC) took another significant step toward achieving our inflation objective by raising the Federal Funds rate target by 75 basis points. In my view, and I speak only for myself, if the data comes in as I expect I will support a similar-sized move at our July meeting. The Fed is "all in" on re-establishing price stability,” Federal Reserve Board Governor Christopher Waller said at the weekend.

To the extent that the above trend in the bond market persists, it could help the Pound to further reverse some of its steep second-quarter decline.

The risk is, however, that the Dollar strengthens irrespective of what happens in the bond market this week if Wednesday and Thursday remarks from Fed Chairman Jerome Powell, or other Federal Open Market Committee members, exacerbate emerging concerns about the prospect of a U.S. or even global recession in the near future.

This is a possibility given the extent to which the Fed and other central banks are increasingly focused on reining in inflation to the exclusion of all other concerns including the possible fallout for labour markets and employment.

Above: Pound to Dollar exchange rate shown at daily intervals with Fibonacci retracements of January and April 2022 declines indicating possible areas of technical resistance for Sterling. Click image for closer inspection.

"Fed officials have pivoted from returning the policy rate to neutral (2.5%) as quickly as possible,to getting policy modestly restrictive expeditiously," says Tommy Kenny, a senior economist at ANZ.

"This week Powell makes his semi-annual testimony to Congress. We expect him to reiterate that the Fed’s overriding objective is to bring down inflation quickly, which will require restrictive policy settings," Kenny added on Monday.

The Wednesday and Thursday Semi-Annual Monetary Policy Report testimonies to congress are the highlights of the U.S. week ahead while for Sterling, there is a lot rested on the inflation data and other economic figures due from the UK on Wednesday, Thursday and Friday.

While Wednesday's inflation data is important for the BoE policy outlook, Thursday's S&P Global Flash PMI surveys of the services and manufacturing sectors and Friday’s retail sales report for May are, arguably, at least as important given the widespread pessimism about the outlook for the UK economy of late.

"We believe that we have reached the point of peak UK pessimism, which leaves us seeing value in GBP/USD around 1.20. However, it seems as if we are clearly in a very small minority and the burden of proof is very much on us," says Paul Robson, European head of G10 FX strategy at Natwest Markets.

"Away from near-term growth and policy concerns, we also expect support from the fact that long-term valuations are starting to look attractive," Robson also said last week.