Yesterday’s speech by Bank of Canada Governor Tiff Macklem was the main event for Canadian investors, however, his hawkish comments had a very muted impact on the Canadian dollar. Speaking at the Halifax Chamber of Commerce, Governor Macklem stated that it is too early for policy to take a “more finely balanced” approach, with inflation still high and the economy operating above capacity. The rare inter-meeting insight into the BoC’s view on the economy helped to offset some of the dovish expectations in markets, leading to a 12.5 basis point rally in the 2-year GoC bond. But, as previously mentioned, the impact of this on the loonie was largely offset by rising Treasury yields, negative cross-asset risk conditions, and a broadly stronger dollar. It is notable, however, that the slight narrowing in front-end rate differentials has helped the loonie notch gains week-to-date in a market that has largely seen the dollar trade higher against the G10. Today, with Governor Macklem pinning some of his hawkish commentary on robust labour market conditions, September’s Labour Force Survey will come into focus. Similarly to the US data, should signs of easing wage pressures appear, hawkish pricing in the rates space will likely unwind, weighing on their respective currencies.
Thankfully, markets don’t need gasoline to go on a journey, otherwise, this week’s round trip back to where we started on Monday would have been expensive, to say the least. After a risk-on rally gripped investors during the first two days of this week, with the sugar high prompting many to say that we’ve seen peak Fed hawkishness as the data now starts to turn, price action over the past two days has largely focused on reversing those initial moves. Stronger ISM services and ADP employment data on Wednesday, and still low initial jobless claims yesterday, has seen the hawks in the US rates space bite back at the doves. Who will ultimately win out of the two this week now largely hinges on today’s payrolls release at 13:30 BST, and given that we have seen very little improvement in the participation rate to date and the payrolls report has largely exceeded expectations over the past six months, we favour further dollar upside heading into the weekend on a more hawkish Fed policy path in markets. This would also be in line with the Fed’s latest communications, of which there was an abundance yesterday. All members supported additional rate hikes into next year, or at least markets buying the idea of it for now.
Similar to the pound, the euro dropped in yesterday’s afternoon session to levels seen at Monday’s open as the pressure on the cross-asset risk environment returned from the US rates space. The sensitivity of the euro to developments in US rates remains high, and with today’s payrolls data proving pivotal for the market’s implied path for the Fed, overnight hedging costs have ramped up yet again. Outside of US developments, a large focus is being given to Europe’s energy market. With wind levels elevated across the continent this week, and EU members considering a temporary limit on gas prices, some semblance of optimism has been baked into overall energy prices. Yesterday’s main release, the ECB’s minutes from September’s meeting, suggested that the consensus among Governing Council members remains for a hawkish near-term path for policy, however, some dissent to a more dovish path is also visible.
The pound continued to underperform in the G10 yesterday, with losses of 1.45% on the day taking the GBPUSD pair down to Monday’s opening level. Sterling’s recent underperformance can be seen in GBP crosses, with GBPEUR the most obvious starting point given its richer liquidity. Against the single currency, which has also been flagging due to precarious energy outlook, the pound has recorded three straight days of losses that sum to over a percent. The pound’s position close to the bottom of the G10 currency board continues today as markets position in the dollar for a stronger payrolls report. Only the kiwi dollar, which is the second best performing G10 currency against the dollar this week, is exhibiting greater losses.
Although not directly related to GBP price action yesterday, the Bank of England’s letter to the Treasury Select Committee drew a lot of overall market attention. Within the letter, Deputy Governor John Cunliffe laid out the rationale for the BoE’s latest emergency measures within the longer-term gilt market. With an estimated £50bn in longer-dated gilts ready to be sold by pension funds in order to meet margin requirements, and these sales set to occur in a highly illiquid market with an average turnover of £12bn a day, the Bank deemed it necessary to be the buyer of last resort. While this has settled conditions in the short-term, the Bank’s £65bn backstop in this market set to expire at the end of next week, with active gilt sales set to start at the beginning of November. Concerns remain high in markets that this will reinvigorate elevated volatility in UK asset markets, potentially causing greater dysfunction in GBP as capital flows intensify and emergency measures from the BoE return to the table.