Yesterday we stated that CAD gains were likely to slow from this point, if not potentially reverse, unless the Fed was taken out of the equation in Q4. While the US CPI release beat expectations, on an unrounded basis the beat was relatively small. Furthermore, most of the reacceleration in the core measure was driven by a rebound in transportation services, which can largely be chalked down to transitory factors like higher fuel prices. As a result, market expectations for the Fed in Q4 were largely unchanged on the day, although expectations of rate cuts in 2024 did receive a little uplift. For the Canadian dollar, the mixed data prompted a spurt of volatility on an intraday basis, but ultimately left the loonie closing flat against the dollar on the day, an outcome that resulted in CAD sitting in the middle of the G10 pack. Today, CAD traders will continue to fixate on the price of oil as it sits just shy of the $90 mark and how fixed income markets trade given key rate decisions out of the ECB and August’s PPI and retail sales data out of the US.
Printing at 0.278% MoM, August’s monthly core inflation data indeed exceeded expectations for a 0.2% print as we expected, albeit only marginally. Furthermore, shelter components, which have been notoriously persistent over the past year, started to show further disinflation while the bulk of the reacceleration in the headline core measure stemmed from the upswing in transportation services that were influenced by transitory factors such as higher fuel costs. All told, while the data did in fact mark a reacceleration in the core inflation measures, including the Fed’s “supercore” measure, the data was well within the margin of error for economists’ expectations and wasn’t concerning enough to really change the overarching narrative on the Fed’s policy path. As a result the initial flurry of USD strength after the report was reversed as quickly as it occurred, while later into the US session the dollar came under renewed pressure as markets shifted their positions heading into key Australian labour market data overnight and today’s ECB decision. This mild bearish bias in the dollar has stuck overnight, with AUD leading gains on a positive employment beat in August and an upwards revision to July’s seasonally distorted data, while the euro also takes some ground heading into today’s ECB decision. While we think a hike from the ECB will likely be euro positive, leading to the dollar DXY index to dip back below our one-month forecast, we don’t think this will necessarily bind as the context of the hike comes amidst a growing stagflationary environment. Stateside, August’s producer price index and retail sales data will also keep traders busy just after lunch, with the data potentially providing some support for the dollar around the ECB decision should it continue to highlight the resilience of the US economy.
Today’s European Central Bank decision is the most contentious rate decision since July 2022, where it shocked market expectations by raising rates by 50bps to effectively exit negative interest rates in one fell swoop. Markets have recently shifted towards our view of a 25bp hike after a Reuters sources story on Tuesday suggested that the 2024 inflation forecast will be revised up from 3%, with a hike now 65% priced in. As a result any upside in EURUSD from the decision to raise the deposit rate itself is likely to be limited. Instead, the emphasis is likely to be on how effectively President Lagarde can sell the ECB’s complete data-dependency as markets are likely to discount the risk of any further hikes given the deteriorating growth outlook. On net, we don’t think the ECB can effectively communicate that all options remain on the table, and if they do, there remains a credible risk of dovish backlash, either officially or through the unofficial “sources” avenue. As a result, we think that any EURUSD rally on the back of today’s ECB decision should be faded by markets. An outright bearish market reaction to a rate hike today shouldn’t be discounted either. Should the 2023 and 2024 growth forecasts be considerably downgraded and suggest that the eurozone economy is close to tipping into recession, any decision to hike rates given this outlook will likely be viewed negatively by markets. While the opposite should therefore be true, we think any decision to hold rates will also be euro negative as it will not only re-widen front-end rate spreads with the US but also raises the risks of inflation persistence in the eurozone. All said, we think EURUSD currently trades rich and we view the risks to the current spot level as tilted to the downside heading into the weekend.
The RICS survey published this morning provided yet another ugly set of data to add to the pile of rapidly accumulating negative readings for the UK housing market. Most notably, the August survey’s headline house price gauge fell to a net balance of -68%. This was the worst reading since the measure was first reported in 1978, excepting the depths of the 2008 housing market crash. Near-term price expectations fared little better, sliding to a balance of -67%. The weakness in the data is notable given that the August survey period followed a significant fall in Bank Rate expectations and mortgage providers trimming rates in response. Taken together, this suggests that the damage to the housing market from the summer spike in anticipated BoE hiking could be longer lasting than many expected, and likely continue to weigh on prices for some time. That being said, for the BoE, this arguably does not change much. Contained falls in house prices are arguably desirable for policymakers given the weight they place on consumer demand. Therefore, unless and until this looks like a runway collapse, MPC members are unlikely to place much emphasis on it in their policy decisions. Given this, the impact for sterling has been muted, at least so far. Following yesterday’s session where the pound traded flat against the dollar and ticked up 0.2pp against the euro as markets largely looked through some soft GDP data, it is little moved this morning again as sterling traders look forward to next week’s BoE policy decision.