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Analyst Mathew Weller, Global Head of Market Research at GAIN Capital reveals the single most important factor driving the rally in the GBP/USD exchange rate that saw the pair peak above 1.4200.

Through a global pandemic, Brexit, US political upheaval, and countless other storylines, there has been one constant in the FX market over the past 6-12 months: A relentless bid for GBP/USD.

After bottoming near 1.1500 as COVID fears peaked last March, the world’s third most-traded currency pair has rallied over 2,600 pips in the past 11 months to crack the 1.4100 handle this week.

What is driving the big rally in GBP/USD?

While there are myriad reasons for any market movement, the single biggest factor powering the ongoing GBP/USD rally is bond yields, or specifically the difference between short-term yields on UK gilts and US treasury bills.

As the chart below shows, yields have been rising faster on 2-year UK bonds than their US rivals, representing a combination of Brexit relief, vaccination distribution, and expectations for a near-term economic recovery:

Above: The Pound-to-Dollar exchange rate and the difference in yields on two-year bonds in the UK and U.S. Source: TradingView, StoneX, reproduced here courtesy of Forex.com. The tightening spread between UK and US short-term bonds makes the UK (and by extension the pound sterling) more attractive to global investors.

Even with today’s pullback in the measure (which has been driven more by a surge in US yields than any particular concerns about the UK economic recovery), the yield on 2-year UK bonds could still “flip” the yield on 2-year US bonds in the next week or two.

If seen, this development could drive additional flows into the pound at the expense of the greenback. In other words, despite the breathtaking surge we’ve seen over the past couple months, there are still potential near-term bullish catalysts for GBP/USD.