GBP / USD rises to 1.3700 as the dollar plunges after CPI, but now looks overbought

• GBP / USD has risen recently and is now testing the 1.3700 level and a key downtrend.
• The USD is weakening after the latest CPI report and Powell’s comments on Tuesday failed to fuel new aggressive line bets from the Fed.
• But GBP / USD now seems quite overbought / overstretched on some metrics, which could hinder further gains.

The rise of GBP/USD has accelerated in recent trading as the US dollar undergoes substantial post-release consumer price inflation (CPI) weakness, with the pair targeting a bullish breakout above a key long-term downtrend and the key level of 1.3700. At current levels, just below the big figure, the pound is trading at its highest since early November, up just under 0.5% on the day and now with gains of around 0.8% on the week. . If GBP / USD can close the week at or above current levels, that would mark a fourth consecutive week of gains during which GBP / USD would have risen an impressive 3.5%. The pair rose more than 4.0% above its mid-December lows of 1.3150.

The rally in recent weeks was initially driven by factors including a drastic improvement in risk appetite, as it became clear that the Omicron variant would be much less severe, allowing the UK economy to avoid lockdowns. That, in turn, boosted market confidence that the BoE will continue its 15bp rate hike in December with multiple additional 25bp rate hikes in 2022. But the most recent bullish leg has more to do with the dollar. The US dollar failed to gain any significant momentum last week amid a sharp change in market expectations for Fed policy. Indeed, the dollar has been falling sharply on Tuesday and Wednesday across the board after That testimony from Fed Chairman Jerome Powell and the latest US inflation report failed to fuel new aggressive line bets from the Fed. In fact, the dollar has been falling sharply on Tuesday and Wednesday in across the board after testimony from Fed Chairman Jerome Powell and the latest US inflation report failed to fuel new hard-line bets from the Fed.

Although fundamentals – tight labor market, strong inflation, aggressive Fed line – arguably still support a stronger dollar in 2022 to a large extent, currency markets appear to be in the process of removing an overly one-way dollar stance. In fact, the most recent positioning data from the CFTC showed a long positioning of the dollar index at a 52-week high in the week ending January 4. A break above the downtrend linking the July, September and late October highs and the 1.3700 level for GBP / USD could open the door for an extension to the upside to test the October highs above 1.3800.

But the pound bulls will become increasingly cautious that the pair will enter overbought conditions in the short term. GBP / USD’s 14-day Relative Strength Index (RSI) recently entered overbought territory (that is, above 70) for the first time since February 2021. Back then, after surpassing 70 on the RSI, The pound had a few more good days before turning sharply lower. Meanwhile, GBP / USD’s Z-score at its 50-day moving average has now risen above 2.0 (implying that it is more than two standard deviations from its DMA of 50). In the last 18 months or so, a Z-score above 2.0 has suggested consolidation or a slower pace of earnings ahead. In fact, looking at the past ten years, GBP / USD’s five-, 21- and 65-day returns after a day when its Z-score at the 50 DMA was above 2.0 is on average negative by 0.2- 0.4%.

Technical levels