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CAD
It is not just Americans that will be celebrating Labour Day, to start the week, with Monday also a public holiday north of the US-Canadian border. Whilst this sets the scene for a quiet day of loonie action, it might be good news for many USDCAD traders, giving them an extra day to digest the groom GDP readings seen last Friday. Admittedly, the main driver for the pair at the end of last week was the release of US data which lit a fire under the greenback more broadly. But despite this it was still surprising to only see USDCAD up six tenths of a percent on Friday. In our view, the Canadian GDP data which showed the economy contracting 0.2% on an annualised quarterly basis in Q2, against expectations of a 1.2% expansion, puts paid to any prospect for further BoC hiking. This should be confirmed when the BoC announces their latest rate decision on Wednesday at 15:00 BST, with the setup suggestive that a further downside move for the loonie is likely incoming.
USD
After a choppy few sessions, the dollar DXY index closed the week out flat, with marginal gains against the euro largely offset by losses against the yen and other higher beta currencies. The substantial rally in the broad dollar to reverse losses earlier in the week occurred late on Friday, shortly after August’s nonfarm payrolls report led the dollar and Treasury yields lower after it showed labour market conditions cooling once again. While the move higher in the dollar and Treasury yields can be partly attributed to the stronger-than-expected ISM manufacturing index, and more specifically the significant positive surprise in the prices paid sub-index, the resurgence in the broad dollar was already in motion before that data saw the light of day. Here, multiple other narratives such as position squaring ahead of a long weekend for US markets and the fact that the US economy is now sucking more people back into the labour market were used to explain the move, but this doesn’t seem significant enough to us to explain the magnitude of Friday’s late rally. More generally, we think price action in the dollar shows a hesitancy by traders to push the greenback below its current ranges, even as incoming data suggests the Fed’s hiking cycle is done and US rate volatility should subside alongside it. With prospective capital returns bleak outside of the US, evidenced once again by the outperformance of US equities on Friday, we think the threshold for sustained dollar depreciation remains elevated and dependent on an improvement in China’s and Europe’s economic fundamentals.
As mentioned, US markets are closed today for Labor Day and as such markets are likely to start the week on a quieter note. However, this is unlikely to be the case heading into the middle of the week as the data calendar fills out. On the US side, the Fed’s beige book of economic conditions and Wednesday’s ISM services PMI will draw a lot of attention, while more generally a lot of the market’s focus will be on the Caixin services PMI from China early tomorrow morning and interest rate decisions out of Australia, Poland and Canada this week.
EUR
The single currency broadly underperformed last week as the discourse quickly turned towards brewing stagflationary concerns on the continent. While this led markets to price out the prospect of a final 25bp rate hike next week from the ECB, which at just 20% is now significantly underpricing the likelihood of a hike in our view, the more dovish expectations didn’t necessarily alleviate pressure on European assets which continued to underperform global peers. These stagflationary concerns peaked when ECB Executive Board member Isabel Schnabel spoke on Thursday, where she signalled to markets that growth data published in the past few weeks will likely lead ECB staff to revise down their growth projections in next week’s monetary policy report. Here, markets focused on the shift in Schnabel’s tone from a more hawkish footing earlier in the year to a more balanced approach to compound the view that the ECB will embark on a pause, but again this overlooks concerns amongst high profile ECB members, including Schnabel, over inflation persistence. With markets underappreciating the risk that the Governing Council will vote in favour of one final hike next week, as per our updated forecast, we think any reflating of hawkish expectations in eurozone money markets this week will weigh on the euro further. President Lagarde’s speech today at 14:30 BST could spark such a move, if not euro bears may have to await the publication of the ECB’s Q2 wage data on Thursday.
GBP
Last week’s sterling price action was largely dictated by events outside the UK, with a light data calendar and many enjoying the last week of summer holidays. As children up and down the country return for their first day back at school, however, the parlous state of many public buildings has been making headlines over the weekend. Granted not a market moving story in the immediate term, but the prevalence of reinforced autoclaved aerated concrete (RAAC) is likely not just limited to schools, and given current concerns will almost certainly result in a very large bill for the Treasury to fix. With government spending plans already extremely tight at the Chancellor’s self-imposed five year time horizon, it seems likely that this crisis is set to place further pressure on an already strained budget. Admittedly, Treasury dark-arts could come to the rescue. But given how the previous Chancellor but one, Kwasi Kwarteng, was punished by markets for his apparent profligacy with public money, either playing fast and loose with fiscal rules or scrapping them altogether carry risks of being poorly digested by markets. Whilst this would clearly weigh on sterling over the longer term, this week a quiet data calendar means that it will be BoE Governor Bailey’s testimony to Parliament that will be the centre of attention for sterling watchers. For markets the key will be if he chooses to reiterate comments by Chief Economist Huw Pill last week, indicating a preference for a high for longer policy approach. If he does, we ultimately think this should be net neutral for the pound, but a sell off in peak bank rate expectations could nudge sterling lower in the short term.