After topping the G10 FX charts last week, the loonie continued to strengthen on Monday, gaining a third of a percent against the dollar. As with last week, the uptrend in oil prices remained the key driver for CAD, which is on track to hit our bullish 1-month forecast ahead of schedule. West Texas Intermediate futures broke above $92/bbl, the highest level for crude since last November, supported by recent OPEC+ supply cut announcements and signs of recovering Chinese demand. Saudi Energy Minister Abdulaziz bin Salman spoke at the World Petroleum Congress in Calgary yesterday, and said that the OPEC production cuts are meant to stabilise the oil market without targeting specific prices, which is a bit ironic considering that crude was rangebound and had been trading sideways for most of 2023. Moving forward, the minister noted that oil output targets would be reviewed on a monthly basis. Aside from oil, yesterday’s data also helped to support the loonie. Housing starts were roughly unchanged, printing close to expectations at 252.8k in August, but industrial product and raw materials prices posted strong beats. Industrial product prices rose by 1.3% vs. expectations for a 0.2% gain, while raw materials surged by 3.0% when an increase of just 1.0% was anticipated. The latest input price figures support our view that today’s CPI report should show inflation picking up again in Canada, and have the potential to beat expectations for readings of 0.2% MoM and 3.8% YoY for all items, which could see the CAD rally continue. That being said, given that Governor Macklem sounded more dovish at the last rate decision, we do not expect near-term Bank of Canada pricing to change much unless core inflation also shoots higher. Besides the usual market moves and data releases, rising tensions between Canada and India are also worth keeping an eye on. Prime Minister Trudeau was heavily criticised by Indian media earlier this month after a disastrous G20 summit, and relations soured even further yesterday after Canadian officials accused the Indian government of assassinating a Sikh Canadian community leader. One of India’s top diplomats was expelled from Canada, and a potential Indo-Canadian trade deal has been put on ice for now.
With a substantial amount of event risk on the economic calendar for the second half of this week, it was unsurprising that markets traded in relatively tight ranges yesterday. In fact, most of the expanded majors closed the day within a +/- 0.4% range against the greenback, with just the exception of the Czech Koruna which closed a percentage point higher after Governor Alex Michl squashed fears that the CNB would follow in the shoes of the National Bank of Poland and prematurely cut rates. Speaking with CNN Prima News, Michl said “inflation is still extremely high, which is why we should all forget about cutting interest rates any time soon”. The rally in the koruna naturally lifted sentiment in the region, leading PLN and HUF to also sit near the top of the pack, while the euro was also on the stronger end of the distribution following an ECB sources story in Reuters stating that the central bank was weighing up options to accelerate the removal of excess liquidity from the financial system. At the other end of the spectrum was the Mexican peso, which exhibited some profit taking after posting gains in excess of 3% in the five days prior, and the Chinese yuan where dip buying in USDCNY below 7.3 continues as we expected.
While action in FX markets was generally muted, the same can’t be said in the commodities and fixed income spaces. After recently breaking through $90 per barrel, all eyes were on oil indices to see whether the next psychological thresholds would be breached. But that would have to wait until this morning, with Brent crude trading through $95 per barrel for the first time June 2022 after data from the JODI showed Saudi Arabian oil production fell 11.6% to 6.01m bpd in July, its lowest level of output in over two years. Nonetheless, the run-up in crude oil yesterday led breakeven rates of inflation to rise across most DM bond markets, while for eurozone govies rates traders also had to contend with speculation of a RRR increase.
Ahead of Wednesday’s Fed decision, which kickstarts a slew of central bank decisions, FX markets will continue to be dictated by positioning in fixed income markets and developments in crude benchmarks. With higher oil prices adding to stagflation concerns across most developed markets and with the US 2-year seemingly holding above 5% for the first time in weeks, the backdrop looks conducive to a mild dollar bid. This has already taken place overnight, with only CAD sitting in the green against the greenback within the G10.
After spending most of the day in relatively tight ranges, the single currency burst into life on another ECB sources story from Reuters yesterday afternoon. This time, the leaks didn’t pertain to staff forecasts, but inside discussions about how to partially drain the estimated 3.7 trillion euros of excess liquidity in the eurosystem. The proposed measure, which is yet to be confirmed publicly by any ECB official, is to raise the required reserve ratio of banks from 1% currently to 3-4%, effectively reducing the amount of available credit in the system and thus aiding the central bank’s efforts to tamp down on inflation. The news piggybacked on speculation within the macro community that the ECB is also likely to accelerate its quantitative tightening programme now that interest rates are seen to have peaked, leading to a further sell-off in eurozone bonds, ramping up yields as a result. While this has helped lift EURUSD back above key psychological levels breached last week following the ECB decision and strong US data, we don’t think this is a sustainable source of appreciation and still believe the right mix of a slightly hawkish Fed on Wednesday and a further deterioration in eurozone PMIs on Friday could unlock the 1.05s for the pair. If realised, this would mark the first time the single currency has plumbed such depths since the collapse of Credit Suisse in March.
Monday’s session saw the pound trade sideways against the dollar, whilst giving up a little ground on the euro as markets digested another hawkish ECB “sources” story through afternoon trading. It is no surprise that sterling broadly traded sideways in yesterday’s session given the string of major economic events on the UK calendar from Wednesday onwards, meaning that most traders are opting to sit on the sidelines in spot markets. However, the same can’t be said for the options space, where one-week implied volatility cracked above 9% for the first time since August 4th, with the skew favouring downside protection.
Given the data calendar doesn’t come online until tomorrow, today looks set to bring more of the same. Later in the week however things should liven up, starting with XPertHR data on wage growth and UK CPI data on Wednesday, before a BoE decision on Thursday and with Friday’s retail sales and a flash PMI reading to round off the week. Here, we still see the balance of risks tilted towards sterling upside, despite the increasingly bearish skew in options markets on the risk of the BoE underwhelming with either a pause or more dovish forward guidance.