It seems that FX traders have run out of reasons to add to bullish CAD positions, even with all the macro factors working in the loonie’s favour. Although intraday volatility picked up considerably, with USDCAD trading in a much wider range than seen earlier this week and getting close to its June lows, the loonie reversed about half of its gains to end the trading session a mere third of a percent stronger against the dollar. Despite the gains, it was still the worst FX performance against USD when compared to every other G10 currency. Even with US inflation missing expectations and igniting a mass sell-off in USD, the Bank of Canada hiking rates to 5%, their highest level in 22 years, yield spreads holding firm against the US, and WTI crude oil breaking above $76/bbl, the loonie’s gains were pitiful when compared to other risky commodity currencies like AUD, NZD, and NOK, all of which well-exceeded 1%. Much of the story, we think, has to do with two elements. First, given that the US and Canada are each other’s top destinations for exports, the interconnectivity between the two economies likely suggested to traders that today’s decline in US inflation to a sequential pace consistent with 2% for the year will soon play out in Canada. Second, Governor Macklem undid a lot of the work the rate hike did on the currency during his press conference. Immediately after the rate decision, money markets were convinced that the Bank would deliver yet another hike in September, pricing the odds above 80%. While the BoC made a very hawkish move in stating that inflation will now return to target by the middle of 2025—6 months later than previously thought—Macklem cut his message at the knees by repeatedly stressing the two-sided risks of both over and under-tightening policy. By the end of the presser, the odds for September had dropped to 66%, and by the end of the trading day, they were all the way down to 33%. We do think that the latest odds are now much closer to fair, with about a 50% chance of another hike at one of the next 3 meetings before the end of the year. Nonetheless, CAD’s inability to grind further is notable, and underscores our view that the path to 1.30 will take a lot longer to travel than just one-month.
FOMC members were in damage limitation mode yesterday, casting a resoundingly hawkish tone as US financial conditions loosened following an indisputably soft inflation report. Ultimately, with the Fed in a data dependent stance, hawkish commentary by the likes of Richmond Fed President Thomas Barkin failed to turn the tide in markets as traders remained fixated on the data showing the slowest sequential pace of core inflation since August 2021. In our view, this in isolation is enough for the Fed to call a halt to its hiking cycle after raising rates a final 25bps this month, and markets soon came around to this reality. Over the course of the day, the dollar sold-off aggressively, notching losses in excess of 2% against the undervalued Scandi currencies and over a percent against all other G10 currencies bar the pound and the Canadian dollar. The move in FX was led by a 12.5bp decline in front-end Treasury yields and a repricing lower of Fed terminal rate expectations. While the readthrough in fixed income and FX markets was relatively clean, the session proved to be a bit bumpier in US equities.
As we have recently noted, traders have been more willing to participate in sessions where the dollar is broadly softening, reflecting in part the overall view in markets that the dollar is structurally overvalued and was likely to weaken this year after a strong 2022. This was on full display yesterday, however, the green light to take the dollar lower by the likely end of the Fed’s hiking cycle led to a less dramatic decline in the greenback relative to when the Fed slowed its hiking cycle towards the end of 2022. Cheaper valuations likely played a role here, but the main discernible difference between then and now are the relative growth factors. With the Chinese and European economies now languishing relative to market growth expectations at the turn of the year, and the US economy continuing to outperform, the dollar is likely to find support once the dovish Fed repricing flushes through. This has been reinforced by China’s trade data this morning, which showed exports fall 12.4% YoY in June and also saw imports contract to a greater degree than expected at -6.8% YoY. However, with Treasury yields still trading lower, down around 6bps on the 2-year, the dollar starts today’s session on the backfoot. The antipodean currencies are leading gains against the greenback following a strong overnight session. For the remainder of today, markets will pay close attention to US producer prices for confirmation that the disinflation trend will remain intact, while the likes of Waller and Daly are scheduled to speak before the Fed enters its communications blackout.
As anticipated in yesterday’s morning report, price action in EURUSD was largely determined by events elsewhere, specifically the release of US CPI numbers. The weaker-than-expected print saw the single currency rise by over a percentage point, a move that left it trading at the highest level since March 2022. As we have noted previously, it is rate expectations that continue to be in the driving seat for the pair. As such, with expectations for the future of the Fed’s tightening cycle already on the table in the aftermath of yesterday’s print, the focus now turns back to the ECB. The lack of economic events in the last few days, together with the scarcity of new inputs from the Governing Council members who in any case seem to have mildly dialled down their hawkish tone, has not been notably supportive for the euro in recent days. Therefore, barring a significant shift in tone in ECB communications, which is unlikely in June’s meeting minutes published today, it seems likely that markets will now have to wait until the next round of PMI release and policy decisions at the end of the month for the next big move in the pair.
As markets continued to digest Tuesday’s labour market data out of the UK, yesterday’s price action saw Bank Rate expectations get trimmed as the signs of weakness evident in the jobs release weighed on the prospects of taking policy rates to north of 6.5%. It was US CPI data, however, that really turbocharged the move, posing further questions over the necessity of hiking policy rates to the extent that was priced in and leading the anticipated peak in policy rates to retreat by almost a full rate hike over the course of the session. Indeed, the August BoE policy meeting which had been seen as close to a done deal at the start of the week with markets looking for a jumbo rate hike, is now seen as more finely balanced, with swap pricing implying a two in three chance of a 50bp increase in Bank Rate. These moves led sterling to trade two thirds of a percent lower against the euro over the course of the day as the pound broadly underperformed much of G10 FX, even as GBPUSD rallied by four tenths of a percent to reach a fresh 14-month high. Whilst this weakness on a trade-weighted basis was not unexpected given the fall in rate expectations, perhaps more surprising was the fact that the pound’s underperformance was not more pronounced.
Today though, all eyes are on housing market data and economic activity figures, both of which were published this morning and told starkly different stories. Beginning with GDP numbers, these saw the UK economy contract by 0.1% in May. With markets having anticipated a 0.3% fall given the impact of an extra bank holiday in the month, activity was actually stronger-than-expected, an outturn that provided a modest boost for sterling to begin this morning’s session. This outperformance was also seen in other activity figures which were published alongside the GDP measure, and broadly pointed to a more resilient economy than predicted. In our view though it is the RICS survey that is ultimately more important for assessing UK economic conditions, and here the news was grim. The survey’s house price balance printed at -46%, a level not seen since 2009. This significantly undershot both expectations and last month’s figures which showed a balance of -30%. The forbidding outlook for UK house prices comes as a direct impact of the recent spike in interest rate expectations, a move that pushed up mortgage costs significantly in June. With the consequences now becoming apparent in the data, sentiment around UK real estate and potential stability risks are likely to resurface once again, a dynamic that should continue to weigh on the pound. However, this is unlikely to be visible against the broadly softer dollar, but instead on a trade-weighted basis as was the case yesterday.