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The Pound to Dollar exchange rate fell to 1.2674 on Thursday following the release of a string of above-consensus U.S. data before recovering back above 1.27 where we find it on Friday, just hours ahead of the week's key data release.

U.S. non-farm payroll report is due for release at 13:30 BST and will give a clearer insight into how the labour market in the U.S. is faring.

The outcome should provide a better sense of whether the recent stabilisation in Pound-Dollar can give way to fresh strength that would ultimately set the pair on course for a retest of 2023's high at 1.2850.

Labour market dynamics are important as they determine wage dynamics, which are a major driver of domestic inflation which the Federal Reserve is trying to suppress via higher interest rates.

The market expects 230k new jobs to have been created in June, a result higher or lower than this would likely determine direction in the Dollar, with bigger moves following bigger misses.

But one analyst believes the risks to the Dollar are not symmetrical as downside risks are heightened on any undershoot.

"If the market sees even the smallest indication that the labour market in the US is not as robust as expected, I expect to see a weaker dollar," says Antje Praefcke, FX Analyst at Commerzbank.

Above: GBPUSD at daily intervals.

Bond yields in the U.S. rose following the release of Thursday's data dump as markets bet the Fed could raise interest rates on a further two occasions, boosting the Dollar in the process. Highlights included a released by the ADP Research Institute revealed that private payrolls rose by 497K in June – more than double the 225K anticipated and significantly above May's 267K increase.

"Investors raised their expectations of the peak fed funds rate in response to Thursday’s labor market data releases, betting that resilient economic conditions will force the Fed to maintain a hawkish policy stance for longer," says a note from BCA Research.

The Dollar would likely benefit again should the non-farm payroll report print hotter than expected, "Another set of stronger numbers should further drive-up expectations for a second hike in September or November FoMC," says Christopher Wong, FX Strategist at OCBC Bank.

The Dollar's Thursday rally ultimately faded as rising U.S. bond yields were matched by rising yields elsewhere given rate hike expectations are elevated globally. For instance, it is the Bank of England which is anticipated to hike the most over the remainder of 2023, offering Sterling support and propping GBPUSD above 1.27.

The Dollar is therefore finding its relative yield support to be 'less exceptional' than was the case in 2021-2022 as yields elsewhere draw attention.

For U.S. bond yields to move materially higher, a significant upside beat in the data would likely be required, particularly as market expectations have become accustomed to accepting stronger-than-expected prints.

Indeed, the non-farm payroll has exceeded expectations for 14 consecutive months now.

This is why "the reaction of the dollar is likely to be more pronounced in case of a disappointing result," says Praefcke.

Looking ahead to next week, "more importantly, we are watching the next CPI print on Wednesday," says Wong.

This should prove to be the main calendar event for the Dollar in July as the outcome would cement the outcome of the Federal Reserve decision on July 26 and firm expectations for September and November.

This week's release of the minutes of the Fed's June meeting revealed there were some board members who would have preferred to have raised interest rates, as opposed to skipping a hike.

This suggests FOMC members are highly attuned to the U.S. economy's robust performance and are wary of nasty upside inflation surprises.

It is therefore too soon to expect an end to the rate-hiking cycle while the start of a rate-cutting cycle looks to be moving further into the distance, suggesting the Dollar can stay higher for longer.

For Pound-Dollar this suggests potential upside will be limited, particularly if UK rate hike expectations begin to cool from exceptionally elevated levels.

"Barring major disappointments, it should not take much to keep the Fed’s hawkish narrative going, and markets should have room to keep inching closer to the pricing in two rate hikes. The path for a more supported dollar in the near term appears to be the most obvious one," says Francesco Pesole, FX Strategist at ING Bank.