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CAD
Although on a headline basis Canadian inflation ticked up in March, the details of yesterday’s report suggested inflation remains firmly on track to achieve the BoC’s 2% target. In our view, this is likely to occur before 2025 as the Bank expects, especially given the pronounced weakness in the underlying pace of core inflation. As a result, we expect the BoC to begin a series of 25bps rate cuts in June, a view that short-term interest rate traders are becoming more sympathetic towards following yesterday’s data. That said, there remains a degree of hesitation to fully buy into our view of 5 rate cuts this year, with traders pricing just 2.5 cuts this year, up from 2.2 prior to the CPI release. Nevertheless, the direction of travel is now the right way, and this led USDCAD to break into our projected range for Q2 (1.38-1.40) yesterday. We suspect the pair has further upside from here as the Canadian data continues to come in relatively weak and the BoC turns materially more dovish.
Beyond March’s CPI report, there were two other notable events for CAD traders yesterday; Bank of Canada’s Tiff Macklem at a fireside chat with Fed Chair Powell and Finance Minister Chrystia Freeland’s Spring budget. However, neither proved deterministic for FX markets. Macklem noted that the inflation data was increasing the Bank’s confidence in cutting rates, but stopped short of confirming a cut at June’s meeting and the depth of easing thereafter. Meanwhile, the Spring budget saw Chrystia Freeland keep her pledge for the budget deficit to remain under C$40bn, but she did spend a new windfall of C$5bn (0.2% of GDP). With most of the spending commitments targeting social programmes and those related to housing skewed towards later years, the budget didn’t shift CGBs all that much from a perspective of rates and overall issuance.
USD
After the People’s Bank of China set the daily yuan fixing above 7.10 yesterday, unlocking another wave of dollar appreciation, all attention turned to Chair Powell to see if the momentum higher in the dollar and US yields could continue. Speaking on the sidelines at the IMF-WB spring meetings, Powell’s tone shifted notably hawkish, leading two-year yields to test 5% for the first time since mid-November and the dollar DXY to extend its gains north of the 106 handle. Speaking on recent data, Powell noted that there was a “lack of progress on inflation”, a marked U-turn from his previous air of confidence, while he noted the Fed’s likeliest response was to keep rates where they are for “as long as needed”. This reaction function is in line with our expectations. Set against data across other DM economies that are showing more sustained progress on inflation, we suspect this stance from the Fed will lead the dollar structurally higher over the course of Q2, even from current levels.
With little on the US economic calendar for the remainder of the week, the focus now shifts to the other side of the equation. On this, another weaker CNY fixing from the PBoC this morning is enough for us to now believe the central bank is conceding to the pressure from higher US rates and is now allowing the yuan to depreciate in a moderate manner, as evidenced by the reduction in CNH liquidity this morning and the still large countercyclical factor in today’s fixing. All told, this should facilitate more upside in USD-Asia pairs, although scope for further upside in USDJPY is limited as it now approaches the next big psychological barrier of 155. Some eyebrows were raised yesterday as the pair dropped half a percent in the US session yesterday, but given the magnitude of the move and its timing, we doubt this was the BoJ’s doing but instead position squaring by US traders. Sticking in the APAC region, the Kiwi dollar is seen leading gains in the G10 this morning, trading 0.4% higher despite it holding the largest sensitivity to US rates. This is on the back of a significant beat in non-tradable CPI data for Q1, which in isolation suggests the RBNZ may be the likeliest candidate to match the Fed in the coming months. Similarly, sterling also trades higher this morning, climbing 0.3% against the greenback and the euro as March’s inflation data also marginally beat expectations, confirming our more hawkish view on the BoE and our take that sterling will be more defensive than the euro in this next wave of dollar strength.
Whether or not the dollar bulls take a breather now or continue to increase the pressure will depend on developments in US yields and the response in equities. Should the 2-year break through the 5% handle and 10-year yields trade through 4.7%, we suspect the DXY index can climb through 106.50 as EURUSD breaks below 1.06.
SGD
In our weekend note we highlighted that upside pressure on USDSGD has intensified in the past week and that it is likely USDSGD will now trade above our 1.35 call in Q2. However, we noted that a return to last year’s highs of 1.37 was unlikely, barring a return to parity in EURUSD and/or an increased tolerance by Chinese officials to CNY depreciation. Arguably, both are now in play, although the more pressing dynamic for markets in the near-term is the shift from Chinese policymakers. With the PBoC now moving into a regime of managed depreciation, we think a retracement in USDSGD to 1.37 is increasingly likely, although we suspect we would likely need to see USDCNY trade up to 7.30 and EURUSD to trade to 1.05 for this to become achievable.
EUR
Although eurozone yields largely tracked Treasuries yesterday, the single currency still traded lower as it “catched down” with its yield differential. The move was also boosted by another negative session in equities, where eurozone measures fell around 1.5% on average, and Powell’s hawkish commentary. With EURUSD trading in the mid-point of our estimated Q2 range (1.05-1.07), we think much of the readjustment with rate spreads has now taken place. We suspect the new round of weakness will likely be slower going and dependent on weak labour market and inflation data. While we do have the final reading of March inflation data today, which provides a more granular look at underlying price pressures, we doubt this will be sufficient to tip the scales and send EURUSD sub-1.06. Any move to this effect will likely be driven by developments in US rates and equities, although it is worth noting that Executive Board member Isabel Schnabel will speak at 16:45 BST. Given Schnabel has been one of the most prominent hawks within the ECB, any dovish rhetoric should be enough to spark another wave of EUR downside.
GBP
Sterling has posted notable gains in early trading as today’s March inflation release confirmed the signal from yesterday’s labour market data – that underlying inflation pressures in the UK remain a little sticker than many had expected, a dynamic that we expect to keep the BoE on hold until the second half of this year. Headline CPI eased marginally to 3.2% YoY in March, down from 3.4% the month prior, but marginally overshooting the expectations of both traders and Bank staff. With smaller than expected falls seen broadly across the details of the release, markets have broadly interpreted today’s data as hawkish for the BoE, dragging the implied odds of a June rate cut down to just 25%, having been close to 75% just one week ago. With FX markets fixated on the degree of divergence from the Fed, and the data now corroborating our view that the BoE is unlikely to cut until August, this should see GBP trade more defensive in the next wave of dollar appreciation, resulting in GBP upside on crosses like GBPEUR and GBPCAD.