GBP USD outlook: USD demise as GBP takes spotlight

The dollar’s demise: When political pressure meets monetary policy

Fed’s new reality

For decades, the Federal Reserve’s independence was the bedrock of global monetary policy. Currently, that foundation appears to be cracking under political pressure. Public criticism from Trump and his appointed governors targeting Chair Powell’s hawkish ‘wait and see’ stance has created broader market concern over political interference. This perceived erosion of the wall between politics and monetary policy is now being priced in by investors as an inherent risk premium.

Key indicators reflect this shift:

• Markets are still pricing in 60-70 basis points cut from the Fed till 2025-end.
• Treasury yields, with the 10-year yield falling to 4.27%, reflect fading institutional credibility.
• The Dollar Index (DXY) hovers around 97.0-97.50, reaching multi-year lows despite recent safe-haven demand buoying the greenback.

This policy uncertainty and weakening of perceived Fed independence directly challenge the dollar’s dominance.

Economic fundamentals underpinned by political risk

The US economy’s Q1 contraction of -0.5% (y-o-y) points to deeper structural issues. While headline GDP weakness can be fleeting, the convergence of political and economic fractures casts a shadow over the dollar’s resilience. The greenback’s deterioration reflects a market revaluation of US institutional risk premium, beyond mere cyclical weakening.

Key pressure points include:

• Private consumption growth significantly slowed, rising merely 0.5% (q-o-q) in Q1, marking its weakest post-pandemic reading amidst a cooling labour market.
• Initial jobless claims show an upward trend, reflecting a softening labour market.
• The recent widening of trade deficits is amplified by aggressive tariff policies and pre-tariff import surges.
• The recent downgrade of US sovereign debt across the board, including Moody’s Ratings to Aa1 from Aaa on 16th May, starkly reflects mounting fiscal deterioration and ratings agencies’ lack of faith in policy makers ability to control ballooning debt.

Sterling’s rise 

Monetary integrity

As markets grapple with monetary interference elsewhere, the Bank of England (BoE) has emerged as a beacon of institutional stability. Governor Bailey’s unwavering integrity, combined with the BoE’s ability to manage tempering services inflation (5.4%) and broader growth concerns, exemplifies astute policy discipline. Such inherent credibility has fostered a yield advantage for investors in sterling, particularly as Fed policy uncertainty persists, proving supportive for the currency.

UK’s comparative outperformance

Britain’s Q1 2025 GDP expansion of 0.7% (q-o-q) indicates genuine economic momentum despite April’s lackluster m-o-m data. While Brexit fears and past economic policy challenges owing Truss’s mismanagement of economic guidance dominated headlines in prior years, the economy has slowly adapted and found new momentum. The current rally reflects the maturing of this prolonged adjustment period, backed by shifting underlying growth drivers.

Key growth drivers include:

• Increased business investment as market confidence returns.
• Resilient consumer demand despite global headwinds.
• Industrial strategy investments in key sectors like AI, life sciences, and clean energy are beginning to yield dividends.

FX markets at work

The multiplier effect

GBP/USD’s breakthrough above the 1.37 resistance level has triggered strategic UK-bound flows. However, the pound’s selective strength, underperforming against the euro (EUR/GBP at 0.853) while gaining against the dollar. This highlights the rally’s true nature, sterling’s strength coming at a point of dollar demise. FX markets are now diversifying away from dollar-heavy portfolios, favouring alternatives with credible policy frameworks. Sterling benefits favourably from this pivot, owing to the UK’s liquid markets and robust fundamentals.