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CAD
The loonie strengthened by about 0.2% against the greenback yesterday on mildly positive risk sentiment as the terms of the US debt ceiling deal were finalised (see USD section). In addition, oil prices rose by 0.5% while Canadian 2Y yields were up 3bps, which also helped to offer a light tailwind for the currency. Unfortunately for the Bank of Canada, StatsCan reported that rising inflation remains the “most commonly expected obstacle” over the next 3 months for Canadian businesses, with 56% suggesting it would be a problem. This is yet another piece of evidence that supports our non-consensus view that the Bank of Canada will likely be forced to hike rates in June (with a risk that it drags its feet and moves in July). Today, the only piece of Canadian data will be the current account balance for Q1. Economists anticipate the deficit will have slightly shrunk to -C$10.22bn.
USD
With the UK and the US both closed for respective holidays, volatility was largely absent in yesterday’s session. However, as traders from both sides of the Atlantic return today, cross-asset price action is likely to be much livelier, especially as President Biden and Republican House Speaker Kevin McCarthy managed to hammer out the terms of the debt ceiling bill over the weekend. While the proposed deal still needs to navigate its way through Congress with about a week until the doomed X-day, the deal looks fairly palatable for both sides. The main component is the spending cap, which is currently set as flat for FY24 and increases only 1% in FY25. The marginal nominal increase in the level of federal spending will be seen as a win for the GOP, especially as it lowers the level of spending after accounting for inflation. For the Democrats, the fact that spending isn’t cut in nominal terms can also be spun as a success. This is reflected in comments from both Biden and McCarthy who believe that despite vocal opposition from a few members within their caucuses, they have enough support from moderates for the bill to pass. For this reason, we expect the deal to make its way through the legislature with little pushback, moving the archaic fiscal problem to 2025.
While there is an early bid in equities this morning as the risk of a US government default is heavily reduced, this hasn’t translated into the FX space where the dollar continues to trade stronger against the entire G10 board. Now, markets have free passage to return to the economic fundamentals, and last week’s US data, which saw stronger Q1 growth and strength in consumer spending persist into April, has only boosted the odds that the Fed takes rates higher at June’s meeting. In fact, swap markets are now pricing slightly higher than split odds that this is the case, while a full hike is almost priced in at July’s meeting. With the Fed still seen as needing to hike, the relative attractiveness of Treasury yields is likely to keep the dollar supported. This week’s labour market data is likely to prove crucial for whether the Fed does indeed hike at the June meeting or awaits further information. While the payrolls data continues to show strength in employment, there are signs that the labour market is providing less inflationary impulse than in previous quarters. Should measures of wage growth and labour demand ease, pricing of June’s decision may continue to hang in the balance.
EUR
News out of Europe has been dominated by developments in Spain in the past 24 hours, with the release of Spanish inflation data and the surprise announcement of a general election. Markets have had a close eye on Spanish CPI over recent releases, with the data having proved a good leading indicator for overall eurozone inflation, which will be published later this week on Thursday. Given this, the latest numbers for Spain print released at 8:00 BST this morning, contains some good news for policymakers at the ECB. Preliminary May numbers showed headline CPI falling to just 3.2% YoY, down from 4.1% in April, with prices outright falling by 0.1% MoM. Crucially, core inflation also fell, coming in below expectations at 6.1%, down from 6.6% last month. With ECB speakers sounding hawkish in recent communications, warning specifically about the risks of stick core inflation, if the trend of Spanish CPI continuing to lead eurozone figures holds then it would suggest these fears may be overblown. Remaining in Spain, Sunday’s latest round of municipal and regional elections showed unexpectedly large losses by the PSOE led by President Pedro Sánchez, to the party of Alberto Nuñez Feijoó. In response, Sánchez announced yesterday in a televised speech that he will dissolve Parliament and call early elections on July 23, throwing the cat amongst the pigeons on the outlook for the Spanish economy, despite the recent good inflation news. For EURUSD, the focus for now remains this morning’s inflation data, alongside news out of the US around the debt ceiling. The pair has fallen around 0.25pp in early trading this morning as markets modestly pared back expectations for ECB rate hikes. However, with a number of ECB speakers due later today, a continuation of the recent hawkish rhetoric may provide some support for the euro, as markets head into a raft of euro area CPI releases over the course of this week.
GBP
With the UK taking a bank holiday on Monday, price action for sterling was understandably muted. The pound rose fractionally against the dollar and around two tenths against the euro, with little market moving news or events out of the UK taking place. Markets did get a new data point to digest this morning however, coming in the form of the BRC shop price index released just after midnight, which showed a 9% YoY increase in prices. Whilst the headline measure rose again, up from 8.8% seen in April, it also pointed to food price inflation beginning to ease, which will come as welcome relief for both households and policymakers at the Bank of England. MPC speakers in particular have highlighted food inflation in recent communications as one of the factors that has been keeping headline CPI elevated, despite the recent fall in energy prices. The BoE and others had pencilled in a fall for April which failed to materialise, and as such was partly responsible for the upside beat in the latest release, with headline CPI coming in at 8.7% YoY vs consensus expectations of 8.2%. As we noted in our CPI reactive, food inflation is still expected to normalise over coming months and as such represents a fall in prices that has simply been delayed, rather than one that would fail to materialise entirely. Despite this, today’s release still points to the May inflation numbers coming out above BoE forecasts. As such we continue to look for a final 25bp hike in Bank Rate in June. Beyond that though, weakness in the data is likely to begin to show through more clearly, giving the BoE confidence to hold Bank Rate at that level for the remainder of 2023. This contrasts with market pricing that currently shows more than four hikes in Bank rate expected this year. With monetary tightening of this magnitude almost certain to push the UK into recession and growth concerns outweighing the benefits from greater carry at this level, a moderation in these expectations may not necessarily be negative for the pound.
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