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CAD
As we expected in Monday’s report, yesterday was fairly quiet for the loonie with nothing on the data calendar. The currency’s 0.3% gain against the dollar saw it sit in middle-of-the-pack within the G10, with the rally helped along by a mildly positive risk tone. We’ve noted in the past that the oil-CAD relationship has become less reliable of a guide, and that was the case yesterday as well with WTI crude surging to its strongest level in a month on rumours swirling about Russian production cuts and Chinese stimulus measures, and a bullish prediction from the International Energy Agency didn’t hurt either. The big news in domestic financial news was that Laurentian is exploring a sale, although this isn’t something FX markets care about. Today, however, is the day we’ve all been waiting for. First up on the calendar is US CPI at 08:30 ET, which will be followed shortly afterwards by the BoC decision at 10:00 ET. We expect the Bank of Canada to hike its policy rate by another 25bps to 5%, a view we first published in our reaction to last month’s decision due to the significant communications shift. Since then, the previously-split consensus has shifted towards our view. All of the big Canadian banks have now joined us in calling for a hike, and the market odds have stabilised just shy of 70% after surging from 50% last week. We anticipate that this will be the last hike of the cycle, as the data should cool sufficiently before September to give policymakers some breathing room. That said, the risks to monetary policy are skewed to the upside given that inflation is still above 2%, the labour market remains incredibly tight, and Macklem has publicly committed himself to finish the job of bringing inflation back to 2% completely. If the BoC hikes shortly after a soft US inflation report, in line with our base case, we think a re-narrowing in US-Canadian yield differentials will take the USDCAD pair back to its year-to-date lows. These levels could also be tested if the BoC’s communications take a more hawkish disposition.
USD
It was a choppy session in global markets yesterday, with the US yield curve bear flattening, global equities rallying by over a percent, and FX returns showing little discernible pattern with NOK, SEK and JPY all ranking at the top of the currency board. What was of note, however, is the fact that JPY continues to climb off of its year-to-date lows, which alongside the 7% YTD rally in GBPUSD and 3% YTD rally in EURUSD has led the DXY index to fall back below the 102 handle and towards its 2023 lows. Mounting expectations that the Bank of Japan will tighten policy via a tweak to its yield curve control framework on July 28th is coinciding with falling US yields to induce a significant unwind of bullish USDJPY positioning. This has led the pair to fall 3.75% over the past five days. The big question for markets is if this move can be sustained over the coming weeks. The first hurdle to the yen’s rally and the broad downtrend in the dollar will come today in the form of US CPI for June at 13:30 BST, where a soft monthly core reading is expected following a significant contraction in Manheim car auction prices on Monday. While the economist consensus foresees a 0.3% MoM print, we’d argue that something more along the lines of 0.2% is currently where markets are positioned given the latest data. Whether the Manheim index is a poor leading indicator of the top-tier release similar to the ADP measure of employment that wrongfooted traders last week ahead of the payrolls report is the big risk heading into today’s session. In the run-up to the data, however, the underlying bias in markets is to sell the dollar and buy Treasuries on growing expectations that the Fed will hit its terminal rate this month.
EUR
As we cautioned in yesterday’s morning note, the US crossover was influential for the single currency yesterday as the introduction of North American traders saw EURUSD retrace its overnight rally. With the overnight session once again proving bullish for the euro as traders position for today’s US CPI release, it looks likely that the pair will be driven by events on the American side of the Atlantic once again today. To the extent that there were notable events in Europe yesterday, the only release that really stood out came in the form of ZEW survey expectations. Whilst the German measure of current conditions are looking a little better than expected, the outlook across the Germany and the eurozone as a whole has deteriorated once again; an outturn that was unsurprising for markets. Outside this, comments from the ECB’s Villeroy in Paris failed to make headlines, with a similar participation by the ECB Chief Economist speaking later today on an academic panel likely to do the same given the venue. Therefore, all eyes will be on the US for the next leg in EURUSD to see if today’s release can stabilise the pair in a higher range, or if we will have to wait until the next round of monetary policy meetings at the end of July for the next big move.
GBP
In contrast to some other recent releases, labour market data published on Tuesday painted a more mixed picture of the UK labour market. Headline wage numbers beat expectations once again, with average weekly earnings increasing 6.9% on a 3m/YoY basis in the May release. Digging a little deeper however, much of the upside surprise actually came from upwards revisions to the April figures. Indeed, once accounting for this, the growth rate of weekly earnings once stripping out bonuses was unchanged this month’s release. This is a shift compared to prior releases, suggesting that the peak in wage growth may be close, or could even now be in. These signs of slowing in the labour market were certainly reinforced by unemployment and vacancy numbers, both of which showed a deterioration in this latest release. In particular, despite pre-release consensus looking for no change in the unemployment rate, yesterday’s figures ultimately saw a 0.2pp increase in the measure, taking it to 4.0%. This is good news for the Bank of England, who after accelerating their hiking cycle in June will be desperately looking for signs that monetary tightening is beginning to slow the UK labour market. On this score, CPI data due out next week is likely to be critical for the Bank of England. Despite dipping in the immediate aftermath of the release, market implied expectations for Bank Rate have since retraced, and currently see a roughly 80% chance of a jumbo hike in August and a likely peak of 6.5%. A weak inflation reading for June could be enough to move the needle however in allowing the BoE to slow policy tightening once again, so for now the August meeting remains live in our view. Until then, markets will have to content themselves with more news of housing market concerns, once again making headlines this morning. The BoE’s Financial Stability Report published earlier today suggested that higher mortgage costs are continuing to weigh on households, and the household borrowing is increasing, albeit arrears remain low for now. Notably, the BoE also said the UK’s eight largest lenders passed the latest stress tests and can cope with rates as high as 6%, something that has been a source of concern given the rapid rise in Bank Rate. The story of how tightening policy is translating into housing market weakness will continue tomorrow with the publication of the latest RICS report on the UK housing market. Given that this edition will coincide with last month’s sharp rise in borrowing costs, analysts are likely to pay particularly close attention. For now though markets appear to be taking a relatively sanguine view on the risks to the UK’s housing market and the overall economic outlook, with the pound up by around half a percent over the course of yesterday’s session against both the euro and the dollar.
FX Elsewhere
The Reserve Bank of New Zealand left the Official Cash Rate unchanged at 5.5% overnight, in line with our expectations and the market consensus. The decision marked the first pause since the Bank began lifting rates in October 2021 from a base of 0.25% and follows the central bank’s forecast from May that the OCR wouldn’t rise any further. Also befitting with this projection, the RBNZ’s updated forward guidance remained neutral, with the MPC reiterating that “the level of interest rates are constraining spending and inflation pressures as anticipated and required.” While the decision to hold fell in line with what economists had expected, it pushed back on the market implied path which envisaged a further hike this year prior to the decision. While this resulted in a 13.6bps drop in the Kiwi 2-year, it has had little impact on the currency this morning as it trades marginally higher against the dollar and flat against its Antipodean counterpart.