The Pound Sterling fell to around 1.3430 against the US Dollar on Tuesday due to increased demand for the safe-haven US Dollar. This decline occurred despite the Federal Reserve’s dovish outlook, which is expected to result in two more interest rate cuts this year.

The US Dollar Index rose by 0.25% to 98.35, reflecting the Dollar’s strengthening against six major currencies. Predictions indicate an 81.5% likelihood of the Fed reducing borrowing rates at its remaining meetings this year, amid weaker labour market conditions and strong consumer inflation expectations.

Bank Of England’s Expected Stance

Meanwhile, the Bank of England is expected to adopt a dovish stance due to concerns over the UK labour market, with the next interest rate decision expected in November. The BoE had forecasted inflation to peak at 4% in September, affecting its gradual monetary easing approach.

The Pound Sterling continued to face pressure, remaining near 1.3440 and below the 20-day EMA of 1.3475. The currency’s technical indicators suggest a sideways trend, with support at 1.3140 and resistance at 1.3726, reflecting its vulnerable position against the US Dollar.

Given the sharp drop in the Pound Sterling, we see an opportunity to position for further downside in the coming weeks. Traders should consider buying GBP/USD put options with a strike price below 1.3400, targeting the key support level around 1.3140. This strategy allows for profiting from a continued decline while capping the maximum potential loss at the premium paid.

The weakness in Sterling is justified by the cooling UK labour market, which will likely push the Bank of England toward a more dovish stance. We’ve seen UK job vacancies fall steadily from their peaks of over 1.2 million back in 2023 to under 950,000 recently, supporting the view that businesses are no longer eager to hire. The upcoming speech from BoE’s Huw Pill on Wednesday is a critical catalyst that could confirm this cautious outlook and send the pound lower.

Potential Risks And Strategies

However, the US Dollar’s strength may not last, which means we must also consider the risk of a sharp reversal. Recent US inflation data, which has cooled to around 3.1%, supports the market’s pricing of an 81.5% chance of two more Fed rate cuts this year. If the political jitters in France and Japan fade, the market’s focus will shift back to the dovish Fed, weakening the dollar.

This conflicting outlook between central banks creates a perfect environment for high volatility. For those uncertain of the direction, a long straddle strategy on GBP/USD, involving the purchase of both a call and a put option with the same strike price and expiry date, could be effective. This position profits from a significant price move in either direction, which seems likely after the central bank officials provide more clarity this week.

We remember the immense volatility in Sterling during the political turmoil of autumn 2022, and similar conditions could be brewing. Therefore, using shorter-dated options to play the immediate bearish sentiment makes sense, while longer-dated options could be used to position for a potential rebound later in the year. Managing position size is crucial, as speeches from Fed and BoE officials could easily cause the market to gap.

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