GBP/USD - Yield differential favors GBP, all eyes on the Fed

GBP/USD ended last week higher by 3%, its highest weekly gains in years as the traders priced-in increased odds of the BOE rate in Feb 2018.

The pound jumped to a high of 1.3616 on Friday after a renowned BOE dove, Gertjan Vlieghe, turned hawkish.

Rally is backed by yield spread

GBP/USD is in sync with the US-UK 10-year yield spread, which continues to narrow in favor of the British Pound.

The yield spread chart shows bearish head and shoulder breakdown, which indicates the spread is likely to narrow further.

All eyes on the Fed        

Stephen Innes from MarketPulse says, " FOMC should begin with its much-telegraphed balance sheet reduction, and while not particularly noteworthy in itself; the market reaction to an announcement on the eventual size of the balance sheet is the great unknown. But ultimately draining the economy of cheap money can’t be viewed as a positive for markets accustomed to feeding off central bank largess. Why investors are so complacent is a mystery, but perhaps the reality check will set in midweek. The market will enter the meeting with 50% probability of a rate hike priced for December, but ultimately investors will focus on the Fed’s inflation forecast and in particular if they have comprehensively overlooked the recent string of weak inflation prints."

The rally in the GBP/USD could stall if the Fed overlooks the recent string of weak inflation print. Furthermore, the USD may also take cues from the rising 2-year yield as it indicates that investors are pricing-out extreme dovishness and expect the Fed to move rates in December.

GBP/USD Technical Outlook

FXStreet Chief Analyst Valeria Bednarik writes-

"Technically, daily indicators maintain their strong bullish momentum, despite being in overbought territory, whilst the 20 DMA turned sharply north far below the current level, all of which supports an expected continuation. In the 4 hours chart, technical indicators also head higher within extreme overbought territory as the price develops well above a bullish 20 SMA, this last some 250 pips below the current level."