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CAD
Bank of Canada day came and went without a bang. Someone who only looked at the USDCAD chart could be forgiven for thinking nothing happened at all yesterday, with the spot price virtually unchanged. The BoC’s rate statement came with few surprises. No change to the 5% policy rate, growth has slowed, core inflation is still too strong, and the door is still open to hikes in the future. The one thing that was slightly surprising was the extent to which the statement kept up the hawkish rhetoric. It’s not totally surprising because financial conditions could prematurely unwind if the communications came off as too dovish. But after cross-referencing the four key metrics the Bank has recently emphasised against the data, we are left with a strong sense that officials are too pessimistic on the future prospects for core inflation. Those four pillars include the evolution of excess demand, inflation expectations, wage growth, and corporate pricing power. With growth coming in slightly negative in Q2, excess demand essentially evaporating, inflation 5-year breakevens are well-anchored around 2%, wage growth high on a year-on-year basis but has completely faded in recent months, and both operating and profit margins for public companies are trending downward, in our view, there’s little other than the resilience of realised core inflation (a lagged variable) that should be worrying for policymakers. Everything else seems to be moving in the right direction. Overall, yesterday’s decision confirms our view that the BoC has likely hit its terminal level, but there remains a tail risk of an October hike should core inflation remain unchanged. Today, we’ll hear from Governor Macklem in Calgary, with a press conference starting at 15:30 EST / 20:30 BST. Given the quiet rate statement, we aren’t expecting major surprises there either.
USD
The US dollar gained alongside front-end Treasury yields yesterday as a strong ISM services PMI for August once again cracked open the door to a further Fed hike this year. The data was expected to show the US economy continued to expand in the third quarter but at a more moderate pace than in previous months, however, at 54.5 the outturn exceeded both pre-release expectations and July’s reading to sit at its highest level since February. While more robust growth conditions in the US aren’t necessarily a surprise for markets, the pace and breadth of growth in consumer-orientated industries was notably more significant than previous measures had suggested. Owing to this, the prices paid and employment indices also ticked up on the month. The uptick in the prices paid index was the most salient for markets as it marks a second month in which it has climbed higher after previously trending lower since April 2022. As such, strength in US growth conditions now not only raises the spectre of a higher neutral rate of interest (i.e. higher back-end real rates) but also brings questions about near-term inflation persistence back to the table. Markets responded to the data by raising the implied probability of a rate hike by the Fed’s next but one meeting in November to a coin flip. This corresponded with a rally in front-end Treasury yields and the broad dollar as a result; only the Japanese yen following precautionary signs of FX intervention from the MoF gained against the greenback in the G10 space yesterday.
This morning, the dollar finds itself trading mixed against the G10 in a much calmer morning session. Once again, all eyes were fixed on Asia overnight, where it was much of the same in terms of market developments. China’s daily fixing of the onshore yuan remained below 7.20, meaning the countercyclical factor in the daily fixing wasn’t far off yesterday’s record of -1139 pips, however, this hasn’t led the onshore rate to trade back below 7.3. Meanwhile, Japanese officials continue to dominate the newswires, with it now the turn of BoJ Board Member Nakagawa to jawbone the currency. In fact, the largest moves overnight took place in the antipodes, and more specifically NZD after jobs data for Q2 came in strong. Nevertheless, price action overall has been fairly contained and we don’t expect that to necessarily change given the light data calendar. Granted, there are a lot of central bankers set to hit the wires today, but from the Fed’s perspective it is unlikely that we will hear anything new. Out of the bunch, New York Fed President John William’s participation at Bloomberg’s market forum at 20:30 BST stands out the most.
EUR
After weeks of being beaten lower by higher US Treasury yields and deteriorating sentiment around eurozone growth conditions, it was noteworthy that the single currency was one of the better performers within the G10 yesterday against the latest wave of broad USD strength induced by higher yields and widening growth differentials. This was largely because near-term expectations of the ECB reflated once again as the ECB Governing Council members that hit the wires generally sounded hawkish despite their predispositions. In this regard, the most impactful comment on the day came from Ignazio Visco, a well-known dove on the Governing Council, who said that the ECB is “near the level where [it] can stop raising rates”. Swap markets took the cue from Visco’s comments that the upcoming central bank decision will be a closer call than they had assumed, and raised the implied probability of a hike by 10pp to 35%. As we have been arguing recently, we think the ECB is more likely to hike than not as deteriorating growth conditions will likely prevent the pause-and-resume approach taken by the Fed. However, while higher near-term rates should provide some support to the euro around our one-month forecast of 1.07, we think ultimately the ECB’s actions will only further weigh on the prospective outlook for growth and capital returns. Today, growth conditions will remain top-of-mind with the release of final Q2 GDP at 10:00 BST, and while there are another batch of ECB members set to speak, given their communications blackout has officially started ahead of next week’s meeting, we shouldn’t hear anything related to the upcoming decision.
GBP
Whilst Bank of England Governor Andrew Bailey was not quite as candid in his comments yesterday as Chief Economist Huw Pill was last week, he still appeared dovish in his appearance before the Treasury Select Committee. Pill’s statement that he favoured a “Table Mountain” profile for Bank Rate had set off speculation that an end to BoE policy tightening is imminent, in line with our long held view on the outlook for UK policy rates. Notably Bailey did not push back on this narrative in his evidence, instead saying that the end of the hiking cycle is now “much nearer”. Indeed, neither did his MPC colleagues Jon Cunliffe or Swati Dhingra, appearing alongside him. In our view, this supports the idea that the BoE will hike once more this month before pausing, for a peak in Bank Rate to 5.5%. While the dovish repricing in short-term interest rate markets weighed on sterling yesterday, leading it to sustain a heavy blow against the dollar and to retrace all of Tuesday’s move against the euro and then some, we ultimately don’t think this outcome for the pound is bearish. After all, in a world where growth conditions are nosediving, especially in the eurozone, a lower and flatter rate profile in the UK should minimise recession risks and improve the UK’s ultimate investment outlook. Obviously this is conditional on inflation coming down in upcoming months as the economy cools, but signs that the UK economy should do just that continue to stack up. This morning though, news that the housing market fell by more than expected has seen the pound dip lower against both once again. According to mortgage provider Halifax house prices fell by 1.9% between July and August, reflecting the ongoing impact of tightening monetary policy on the wider UK economy, a dynamic that should ultimately weigh on sentiment, spending and inflation in turn. That being said, the falls remain modest for now, with the YoY decline only printing at 4.6% this is unlikely to trouble the Bank of England from a financial stability perspective. Instead, continued signs of cooling will likely be welcomed on Threadneedle Street as yet another sign that policy tightening is close to done.