Despite softer than expected loan demand the pound appears to be strong as yield differentials are the UK currency to gain traction against the greenback. Sterling has been one of the best performing currencies following last week’s unemployment report which showed a decline below 5.4%. The Bank of England believes this is their target level where wage inflation begins to accelerate which has pushed up short term yields and given hope to sterling bulls that the BoE will raise rates in the first quarter of 2016.
Looking forward, traders will now focus on the UK Retail sales report which is scheduled to be released on Thursday. Retail sales will reflect consumer sentiment which will allow investors to see if the decline in unemployment has spilled over into consumer spending. If wages really increased by the 3% year over year rise reported, then consumer will have likely used those increases to spend on goods and services. Expectations are for an increase of 0.4% month over month compared to the 0.2% increase seen in August.
The strong jobs number in the UK come just when the US has started to falter. The US September jobs numbers were weaker than expected, and the wages gains were also subdued. This news came subsequent to the FOMC meeting which had the Fed keep short term interest rates unchanged. The following Fed minutes where more dovish than expected as it appeared that the Fed was not as close to pulling the trigger as many had expected. The Fed has tried to offset the dovish bent with many FOMC voters still saying that they believe that the target Fed funds rate will rise during 2015.
There comments have not been embraced by interest rate traders. Fed fund futures contracts, which reflect the markets perception that the Fed will change rates, are pricing in a 5% chance that the Fed will raise rates in October, and a 25% chance that the Fed will increase rates in December. This is down from 30% and 50% just 4-weeks ago. The market now says that there is a 50% change of the Fed raising rates in March of 2016.
The change has spilled over into the interest rate differential which drives the forward curve in the forex market. The weekly 2-year yield differential between theUK and U.S.are facing resistance near the 10 basis points level. Yields differentials are generally considered a strong driver of a currency pair and a break of this level will likely drive the GBP/USD higher.
The GBP/USD bounced off of support on the currency pair is seen near the 10-day moving average at 1.5395. Momentum on the currency pair is positive with the MACD (moving average convergence divergence) index generating a buy signal in early October. The index is printing in positive territory with an upward sloping trajectory that points to a higher exchange rate.