1.3420 Session Highs for British Pound as US Dollar Weakens Broadly

1.3420: GBP/USD rallies from below 1.3350 as stronger risk appetite weighs on the US Dollar.
Oil holds close to two-month lows as investors hope for a negotiated end to Iran's war.
Further US Dollar losses are likely to be contained by robust US economic figures and expectations of Fed tightening.

GBP/USD is trading around 1.3420 at the time of writing. Having rebounded from Friday’s lows below 1.3350, the British Pound (GBP) is recovering most of the previous two days’ losses on Monday. Upbeat market sentiment is weighing on the US Dollar (USD), while bulls are looking towards last week’s highs near 1.3500.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

A brighter risk backdrop is prompting investors to sell the US Dollar on Monday and buy currencies perceived as riskier, including the British Pound. Reports of progress towards a US-Iran peace agreement have, for now at least, countered last week’s concerns over an AI bubble. Oil prices are consequently holding steady close to two-month lows.

With no major US or UK data releases scheduled for Monday, last week’s hawkish-leaning Bank of England (BoE) monetary policy statement is providing some support for sterling. Last Thursday, the BoE adjusted interest rates by a quarter point to 4%. Some policymakers argued that additional increases were needed to return inflation to target. Governor Bailey backed that position, keeping further monetary tightening on the table.

US data and Fed rate-hike bets set to cushion Dollar declines

The US economic backdrop, however, has favoured the Dollar. An above-forecast October Nonfarm Payrolls (NFP) reading and a fall in the Unemployment Rate created conditions conducive to further Fed monetary tightening. Following the NFP report, Fed policymakers highlighted elevated inflation pressures, fuelling expectations of a December rate increase.

Attention therefore turns to Tuesday’s US Consumer Price Index (CPI) release, the key focus this week. The figures are expected to indicate a further acceleration in prices during October.

According to ING strategists, “contagion from AI to defensive stocks in the US and worldwide allowed the Dollar to rally even before the strong US jobs market report.” They nevertheless warn that the advance may not last, arguing that “unless risk sentiment remains poor this week, lower front-end US rates should favour a weaker Dollar, even if inflation tomorrow comes in slightly hotter than expected.”

Risk sentiment: key questions

How do “risk-on” and “risk-off” describe financial market sentiment?

Investors’ willingness to accept risk over a given period is commonly described in financial markets using the terms “risk-on” and “risk-off”. Optimism about the outlook characterises a “risk-on” market, encouraging investors to purchase riskier assets. When markets turn “risk-off”, concerns about the future lead investors to ‘play it safe’. They favour lower-risk assets offering greater certainty of a return, even when that return is relatively modest.

Which assets best indicate shifts in risk sentiment?

A “risk-on” environment usually lifts equities and most commodities other than Gold, as a favourable growth outlook supports their value. Stronger demand also boosts the currencies of major commodity-exporting nations, while Cryptocurrencies advance. By contrast, “risk-off” conditions support Bonds, particularly major government Bonds, as well as Gold. Safe-haven currencies, including the Japanese Yen, Swiss Franc and US Dollar, also tend to benefit.

Which currencies typically gain in a “risk-on” market?

Currencies that typically strengthen in “risk-on” conditions include the Australian Dollar (AUD), Canadian Dollar (CAD) and New Zealand Dollar (NZD), alongside less heavily traded currencies such as the Ruble (RUB) and South African Rand (ZAR). Their economies depend heavily on commodity exports to drive growth. During risk-on periods, investors anticipate that stronger economic activity will increase future demand for raw materials, tending to push commodity prices higher.

Which currencies typically gain in a “risk-off” market?

“Risk-off” periods generally favour three major currencies: the US Dollar (USD), Japanese Yen (JPY) and Swiss Franc (CHF). The Dollar benefits from its role as the world’s reserve currency and from crisis-driven purchases of US government debt. Investors regard that debt as safe because the world’s largest economy is unlikely to default. Demand for Japanese government bonds supports the Yen: domestic investors hold a large share of these bonds and are unlikely to sell them aggressively, even during a crisis. For the Swiss Franc, support comes from Switzerland’s strict banking laws, which provide investors with greater capital protection.