The Canadian dollar was the weakest G10 performer yesterday as it fell over half a percent despite a broader environment of a weaker dollar. Downside in the loonie was driven by the rout in equities, lower growth, and still tepid GDP data, with the latter confirming our view that the BoC is entering the final stages of its tightening cycle. Today, focus will rest heavily on the performance of North American equities after a 2% slide in the S&P 500 was recorded yesterday.
A slight moderation in volatility within the cross-asset space from this week’s highs saw the dollar selloff continue yesterday, marking a 2.2% drop from Wednesday’s 20-year high. Although part of this was likely due to month-end and quarter-end rebalancing out of favoured USD longs, which could persist in towards the weekend, we think the bias in the dollar over the coming weeks remains to the upside. Firstly, the economic fundamentals in Europe remain under substantial pressure, and while France and Spain’s CPI will have eased some of the concern among ECB officials following the substantial inflation surprise in the German inflation report, the ECB remains on a significant hiking cycle as the economy heads into recession over the winter months. Furthermore, geopolitical tensions remain pronounced and President Putin’s address at 13:00 BST today will likely see headlines thrust this risk back into direct view for investors. Finally, cross-asset volatility remains near 2020 highs despite the recent moderation. Amid this environment, not only is the dollar a favoured expression within FX markets, but so is its carry, which remains supported by a Federal Reserve that is highly committed to its inflation fight. Yields will be in focus today, not only because of their impact on equities which have now gone through June’s lows but also due to August’s PCE inflation data due out at 13:30 BST. The report should see similar dynamics to the CPI report: a moderation in headline inflation while an uptick in the core measure.
The single currency has rallied over 2.3% since Wednesday’s open, with 0.83% of the rally occurring in yesterday’s session alone. While most of this recovery is due to technical factors, such as the recovery in sterling and rebalancing effects, cheap valuations are likely at play as well. This morning, most of the focus rests on the market reaction to France’s CPI report as it joined the Spanish data in undershooting expectations and cooling from the previous month in both annualised and monthly terms. In addition, consumer spending also held up in France over August, confirming the dispersion among the PMI reports that show France’s economy maintaining economic momentum better than its regional peers. Today, the focus for EURUSD will sit with broader market moves, while we expect the eurozone CPI report to have little impact seeing as the bulk of the inflation message has already been delivered.
The recent rally in the pound to just 1.26% below pre-budget levels and 7.5% higher than Monday’s all time low has naturally brought about the conversation of whether the recent depreciation is over and if investor sentiment has recovered following the growing pains brought about by the Government’s pro-growth plans. While developments overnight have been positive, with the Treasury Select Committee Chair Mel Stride publicly announcing that the OBR’s full budget projections could be brought forward to the end of October according to the think tank itself and some Tory MPs suggesting they will vote against the 45% tax cut, we don’t think it warrants such a large retracement in the pound. Additionally, price action in other UK asset markets suggests that investor sentiment still remains hesitant; the FTSE 250, a better gauge of UK companies than the export orientated FTSE 100 index, continues to tank with a 3% drop yesterday alone to a 2-year low, while gilt yields continue to climb with the 2-year climbing 11bps higher yesterday towards this week’s highs. Given current valuations and still shaky fundamentals, we expect the bias in the pound to continue to be lower in the short-term, but note that sentiment over the medium-term is skewed towards GBP upside such that any slip in US PCE data today could provide further upside in the pound heading into a weekend that will be brimmed with political noise.