GBP/USD forecast: Fed dot plot, US inflation set to shake things up

• GBP/USD has been heavily influenced by risk appetite recently
• Fed interest rate decision, US CPI/PPI headline event risk
• Downside risks both in the near and medium-term are growing

The Federal Reserve June FOMC meeting and US consumer price inflation for May look set to dictate directional risks for GBP/USD this week, overriding anything on the UK economic calendar including Britain’s unemployment report. Risks look skewed to the downside.

Risk appetite driving GBP/USD

Looking at the daily correlation between GBP/USD and other financial assets over the past month reveals the strongest relationship has been with bitcoin at 0.88, surpassing that of EUR/USD with a score of 0.64. That’s unusual.

While I doubt GBP/USD is being significantly influenced by bitcoin’s gyrations, given the correlation between GBP/USD with Nasdaq futures and Nvidia’s share price of 0.71 and 0.75 respectively, it suggests risk appetite is being particularly influential right now, rather than interest rate markets directly.

But I’m not going to kid myself. Because when it comes to what will influence risk appetite next week, it will almost certainly be driven by expectations for what the Fed may do with interest rates outside of a black swan event.

US CPI, PPI easy to interpret

The reaction to the US CPI and PPI reports is easy to assess; markets look for underlying consumer price inflation to increase 0.3% while final demand PPI is tipped to lift by a smaller 0.2%.

Any undershoots on those forecasts would likely see risk rally as Fed rate cut bets swell, especially if accompanied by signs that services prices, or those that feed into the Fed’s preferred PCE inflation measure, are softening.

But if the prints surprise on the upside it’s likely riskier asset classes will struggle, including GBP/USD.

FOMC contains multiple risks to navigate

Either side of the CPI and PPI reports, the Fed will announce its rate decision on Wednesday afternoon US time. With the funds range set to remain at 5.25-5.5%, the updated dot plot – where individual FOMC members provide forecasts on where they see the funds rate in the future -- will initially be the focus of markets.

When released three months ago, the median projection signalled three rate cuts in 2024. Had one member moved their forecast higher, it would have only stood at two. On this occasion, the question is likely to be whether the median forecast will be for one or two cuts this year, in part due to the stickiness of inflationary pressures but also because we're nearly halfway through the year.

While past performance is not indicative of future results, the median 2024 dot has come in dovish to economist expectations in both December and March. So, it has dovish form on the board.

With markets now favouring just one cut from the Fed this year following Friday’s blowout nonfarm payrolls report, if the dots signal two cuts, risk assets are likely to rally in response.

Like the dots, Fed Chair Jerome Powell has dovish form on the board, often sounding far more eager to begin easing rates than other FOMC members this cycle. That’s something to remember before he fronts the media following the rate decision.

Remaining calendar contains minor residual risk

Outside the inflation reports and Fed meeting, other risk events play a distance second-fiddle this week.

There may be short-term bouts of volatility around the UK unemployment figure on Tuesday and Wednesday’s UK GDP report, but those events will be overshadowed relative to what’s going on across the other side of the Atlantic.

While it can be hit and miss when it comes to market impact, the US Treasury is auctioning three and 10-year notes early in the week. Back in May demand for similar tenors was particularly weak, causing yields to spike resulting in weakness in riskier asset classes.

Unless there’s renewed concerns about the ability for the Fed to cut this year, the auctions should come and go without noticing. But you never know.

GBP/USD technical view: downside risks

Before looking at the near-term GBP/USD outlook, it’s always useful to look at the weekly charts for clues on longer-term directional risks.

When it comes to cable, the price sits in a clear bull pennant pattern, hinting that when the next big move comes, it’s may be a topside break. But looking at the recent price action, the inverse hammer candle last week completed an evening star pattern, warning of potential near-term downside risks.

The possible bullish break may have to be put on ice for now.

Zooming in to a daily timeframe, you can visually see how poorly GBP/USD has fared at 1.28 recently, only managing one clean break it since August and even that one was short.

The large bearish candle on Friday also completed an evening star pattern, hinting a retest of support below 1.2700 may be on the cards in the absence of a resurgence in risk appetite. With price and RSI diverging over the past month, and MACD about to cross over from above, risks look skewed towards the downside.

Below support between 1.2780-1.2800, 1.2635, the 50 and 200-day moving averages (although the price has rarely respected other lately), and 1.2450 are downside levels to watch. On the topside, should selling at 1.2800 give way, 1.2894 would be the first obvious target with 1.3000 after that.

-- Written by David Scutt

Follow David on Twitter @scutty