News & Analysis


Yesterday, the Bank of Canada hiked 50bps, meeting our expectations but falling short of the 75bps that most forecasters and money markets had foreseen. While the reaction in both rates and equity markets was straightforward (yields down, equities up), the knee-jerk sell-off in the loonie quickly reversed. One potential explanation for this counterintuitive price action is that FX traders are starting to pay less attention to Canadian developments, and more so on what this means for the Fed and the timing of the risk-on rally once the pivot in US policy begins. This morning, following a 0.4% rally in yesterday’s session, the loonie is down 0.2% as the broad dollar fights back.


Following a mild sell-off on Tuesday, the dollar’s downside was extended in yesterday’s session as it turns out the Fed isn’t the only central bank that can move global markets. Similar to the Reserve Bank of Australia at the beginning of the month, the Bank of Canada’s decision to tread more carefully in this stage of its hiking cycle due to growth and financial stability risks arising from over tightening acted as the canary in the coal mine for G10 central banks. Core bond yields fell following the BoC decision, led of course by Canadian yields, which boosted risk assets across the board. While micro-level stories resulted in US equities closing in the red, the signs of central banks starting to pivot was enough for FX markets to trim “the most crowded trade” within the cross asset space: long USD. This saw the dollar DXY index compound Tuesday’s losses with a further 1.14% drop to reach levels not seen since the Fed’s September meeting. Today, however, the dollar is back on the ascent as it starts this morning by recouping losses against the bulk of the G10 currency board, except the Japanese yen. Although the ECB will garner a lot of attention today, and given the euro’s weighting within the DXY index it could dictate broad USD price action, the US data calendar is also likely to support a retracement in yesterday’s price action. At 13:30 BST, markets will receive the preliminary Q3 GDP data, which is expected to print at 2.4% QoQ annualised. Any upside surprise will consolidate the view that the US economy is withstanding the Fed’s hiking cycle than initially concerned. The GDP data comes ahead of tomorrow’s inflation and employment cost index data, which will likely prove more pivotal in turning the tide for the greenback.


The euro continued to rally in the improved risk-on conditions yesterday, consolidating earlier gains to trade 2.4% higher over the first three days of the week. While a large portion of the euro rally can be attributed to the improvement in cross-asset risk conditions, it also likely reflects the improvement in energy market conditions and the narrowing spread between the Italian and German 10-year bond yields, which has fallen almost 12bps since Friday, to 2.21 bps. This theme reveals there’s still a margin for the ECB to deliver a consensus 75 basis points hike today. However, given the firm expectations for such a move, much of the focus today will be on the ECB’s forward guidance, in either explicit terms or implicitly through the tone of President Lagarde’s comments on inflation and growth, along with technical adjustments to its policy framework now rates are in positive territory. Currently, consensus expectations for the December meeting look for a further 50bp hike, bringing the deposit rate to 2%. We expect Lagarde to compound these expectations, and confirm that further hikes are necessary despite the fact that the eurozone economy is entering a recession. This should be confirmed by tomorrow’s data, where at least the German economy will print data that shows economic activity contracted on a quarterly basis in Q3.


The pound surged higher shortly after the London open yesterday as a short squeeze in both the GBPUSD and EURUSD occurred after key psychological levels were broken. These early gains in the pound were initially trimmed after news that the UK budget would be delayed from October 31st to November 17th, as concerns over the large fiscal shortfall reared their head again. However, the moderation in the pound was quickly reversed as markets turned visibly risk-on in the afternoon session following the dovish repricing in US rates post Bank of Canada. Trading at levels not seen since before Prime Minister Truss’s stint, sterling is now substantially overvalued relative to its fundamentals in our view and remains subject to a sharp reversal should the Fed reinforce a significantly hawkish message next week that weighs on risk appetite. On the economic fundamentals, major accountancy firm EY reported that mortgage approvals next year may total just £11bn, a fraction of the £63bn expected for 2022, while HSBC have estimated that home prices may fall 7.5% nationally and 15% in London.



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