With stronger US growth conditions in the driving seat for markets last week, it was no surprise to see the Canadian dollar close to the top of the G10 currency board as the currency continues to show defensive characteristics to a potential extension in the Fed’s hiking cycle. However, the loonie’s relative outperformance was somewhat undermined on Friday by Stats Canada’s flash GDP data for June, which showed the economy contracting by 0.2%. The data, if confirmed in the final reading, shows growth likely undershooting the BoC’s estimate for Q2 and as such confirms our view that the central bank is likely done with its hiking cycle. While markets are slowly coming around to our base case, a further hike is still 50% priced in other the next two meetings. It is in this light that Friday’s labour force survey data for July will land. Any weakness, especially in the wage data and the unemployment rate, will likely result in a further sell-off in CAD.
Markets start this week in the same vein in which they closed on Friday, with one eye on developments in Japan and another on global growth conditions. With the former, news overnight that the BoJ had conducted unscheduled bond purchases reinforces the idea to markets that while the central bank will allow 10-year JGB’s to yield more than 0.5%, the adjustment period would be slow and yields will be calibrated relative to the Bank’s view on underlying economic conditions. In our view, while the BoJ actions represents effective monetary tightening and the start of a more prolonged normalisation cycle despite rhetoric from the BoJ and the conditionalities of the YCC adjustment, last week’s meeting doesn’t necessarily represent a regime shift for USDJPY. This has been reflected in spot price action in the pair, which continues to slide back into the 140-145 pre-decision range. The response in spot markets underscores why we preferred to play last week’s decision in the options space.
The other driver of FX markets last week was growth data, which once again showed relative US exceptionalism despite stronger-than-expected growth in France. This saw the dollar remain well supported either side of Wednesday’s Fed decision as markets continued to favour exposure to US assets while the risk of an extension to the Fed’s hiking cycle in Q4 remained priced into short-term interest rate products. The relative strength in the US growth profile remains on show again this morning as China’s NBS PMI measure of non-manufacturing activity nosedived from 53.2 to 51.5, below expectations of 53.0. However, while the slower growth data is once again weighing on the Chinese yuan, news that officials are once again extending support to the ailing housing market and the consumer has provided a moderate boost to APAC equities and currencies overnight, with AUD and NZD leading gains this morning. This price action falls in line with what we warned about in our preview last week. That is, bad news on the growth front may be good news for markets given it will likely induce a policy response. For the remainder of today, growth conditions will remain front and centre as markets continue to digest the effectiveness of the Chinese stimulus while the eurozone composite flash GDP measure for Q2 is released alongside July’s flash inflation report at 10:00 BST. A weak reading on both fronts here could send EURUSD back below the 1.10 handle, spurring renewed dollar strength at the start of this week.
The single currency bounced towards the end of last week, trimming losses to just below a percent on the week as growth data out of France and Spain pointed towards a more resilient growth outlook while national inflation data cooled across the board. Although the growth data wasn’t necessarily as strong as that seen in the US, especially considering France’s beat was due to transitory factors, it did highlight to markets that the end of the ECB’s hiking cycle isn’t necessarily a foregone conclusion. This was reiterated by President Lagarde over the weekend. Speaking with the French daily newspaper Le Figaro, Lagarde stated that there could indeed be a hike after a potential pause at September’s meeting, while she also labelled second quarter GDP data as “quite encouraging”. For EURUSD traders today, this view will be stress tested once again with the release of the eurozone composite flash Q2 GDP and July CPI reports at 10:00 BST. If the data shows a more moderate growth profile than that eluded to by the national data alongside a substantial moderation in core inflation, renewed downside in EURUSD and eurozone yields is likely.
Despite falling considerably on Thursday on the back of stronger US growth data and a more dovish ECB meeting which weighed on BoE expectations, the pound rallied on Friday to close to the week out flat against the dollar and moderately higher against the euro. Overall, despite the continued volatility in the pound, the macro backdrop remained relatively unchanged as little data was released. That won’t be the case this week, with the Bank of England set to announce its latest policy decision on Thursday alongside a fresh set of projections. While markets have become a lot more sanguine on the prospect of a 50bp hike in Bank Rate, we note that the risk of such an outcome remains elevated. Should the BoE double down on June’s decision with a second 50bp hike, we expect further GBP appreciation against both the dollar and euro given the pound’s continued sensitivity to rate differentials.