Are The Rising US Bond Yields Sending Sterling Into Reverse?

Marius Paun | London, UK | Senior dealer | Thursday, 04th March 2021

The recent rise in US bond yields weighed on the stock markets as investors have become concerned that future inflation could run rampant. In turn, that could force the US Fed to raise interest rates sooner rather than later.

The pound sterling was also affected by the rising US yields. It did rally to 1.4241 against the dollar last week but eventually retreated under 1.40. Following dovish remarks from the Chairman of the Federal Reserve Jerome Powell on Thursday afternoon, the pound failed to post a meaningful rally as yields continued to go higher.

However, some support was offered to the pound by fresh news on the trade agreements between the US and the UK. London suspended tariffs on some US goods at the beginning of 2021. It might have been that the UK was forced to introduce them as being part of the EU, which had a trade dispute underway with the US. Washington decided to return the favour and removed tariffs on some UK goods like whiskies, cheese, machinery etc.

Politicians were quick to point out the improved trading relationship with the US and that it’s possible to have a non-tariffs agreement even if negotiating as a single country rather than a bloc. The sterling was also supported by Wednesday’s UK budget announcement as well as the ongoing vaccine rollout which many see as a success of underselling and over delivery in Britain.

By and large, it was a buy now pay later budget. The UK Chancellor Rishi Sunak expressed his views of protecting the recovery, pay for it later but be transparent and lay out the plans now. That way investors will not be spooked and taxpayers will have time to put their finances in order well in advance. He promised to extend all of the support scheme’s, furlough, universal credit, reduced VAT, stamp duty holiday until the end of September.

Chancellor Sunak also added something new, an incentive to pull forward companies spending plans. By encouraging firms to spend some extra on investment he offered a ‘super deduction’, a 130% tax relief for qualifying plant and machinery. Due to those extra incentives, the Office for Budget Responsibility said the GDP will increase by over 7% in 2022!

The payback will start in 2023 though. The corporation tax rate is going up by 6% from 19 % currently to 25% which is quite hefty despite the fact that it will remain the lowest rate in among G7 economies according to the UK Government. On the other hand, companies with profits below £50,000 won’t be affected. The full 25% will be paid by companies making a profit above £250,000.  So, the pound enjoyed a nice rally but, given the current turbulence in the US, can it last much longer?

The chart shows GBPUSD continuing its steady increase this year touching 1.4241 on February 24th, last seen in April 2018. The upward trend looks intact. The short-term moving averages are still above the long-term one and both still pointing higher. For now, the price has bounced off the short-term MA.

We could see some consolidation around the current levels. Nonetheless, the bulls will want to see a close above 1.4035 to prove the rally has legs. If that comes true it could spur additional buying power and the next resistance at 1.4240 may come into focus. On the downside, sellers will want to push the price back below support at 1.3860 followed by 1.3750. Next, resistance turned support at 1.3520 should pose a more serious question for the bears as it also matches the 21 days MA (blue line).