News & Analysis

USD

Yesterday marked another quiet day in FX markets as traders continued to adjust to the events of last week and position for key economic events outside of the US this week. As noted yesterday, two currencies stood out last week for their notable underperformance; both CAD and GBP lagged the rally in G10 FX against the softer dollar as markets continued to hold a dovish view on their respective central banks. Heading into Thursday’s Bank of England meeting and Friday’s Canadian jobs data, both sterling and CAD lag the rest of the G10, as rates traders continue to hold dovish views of their respective central banks. While we agree with market price action in the case of CAD, we think it remains too early to confidently bet on the BoE turning dovish. Any absence of the BoE pivoting in a dovish direction on Thursday should therefore prompt a retracement in UK rates and allow sterling to catch up with peers.

While both CAD and GBP notably depreciated against the dollar yesterday, there was one worse-performing G10 currency. The Japanese yen fell four tenths of a percent against the dollar, even as Treasury yields extended last week’s moves, with the 2-year yield falling back below 4.8% and the 10-year falling below 4.45%, before modestly retracing. As we noted following last week’s intervention, the BoJ’s actions didn’t address the root cause of yen weakness and thus merely acted as a speed bump for JPY depreciation. Accordingly, yesterday’s renewed yen weakness didn’t come as a surprise. In fact, we suspect further upside in USDJPY is likely ahead of the next pivotal event for US yields–April’s CPI release on May 15th.

One other notable theme in markets yesterday was the outperformance of high yielding currencies. Having come under pressure throughout March from higher DM yields and increased cross-asset volatility, the prospect of lower yields and overall market volatility saw traders flood back into previously popular carry trades. This benefitted high yielding LatAm currencies the most, even as both BRL and MXN are subject to the risk of rate compression later in the week with both the BCB and Banxico set to announce their latest decisions this week. Indeed, the market focus for today and tomorrow is likely to be squarely on central bank action outside of the US, with a Riksbank decision this morning first up, before the aforementioned BCB decision later this evening and policy announcements from the BoE, Banxico and NBP all due on Thursday. While likely to only be of marginal consequence for the broad dollar, we still expect this to see some interesting price action play out on the other side of dollar pairs.

EUR

Price action in EURUSD was nothing to write home about yesterday, with the currency trading in a tight 0.4% range for the day. Moreover, with little by way of significant data releases out of the bloc, today is unlikely to prove much different. This should leave euro traders to focus instead on periphery currencies, with SEK standing out in particular. While weaker-than-expected inflation and activity data since February warrants the Riksbank cutting rates, the krona has failed to strengthen in line with Riksbank forecasts and any rate cut would almost certainly exacerbate this situation. With the central bank having previously proven highly sensitive to SEK weakness when setting policy, the decision looks close to a coin flip in our eyes. That said, if we had to pick a side, we think the balance of risks is titled marginally in favour of defying both economist and market expectations today to hold rates at 4%.

GBP

Minimal domestic data outturns saw the sterling trade in line with broader cross asset dynamics on Tuesday, as UK traders enjoyed a relatively slow return to the office following the early May bank holiday. Significantly, this left sterling at the mercy of bond markets, with Gilt yields having fallen the most amongst DM peers post-RBA, excluding Australia, this dynamic saw GBP underperform. All told, it was sufficient to see GBPUSD slide by four tenths, while GBPEUR also fell by 0.1% on Tuesday. Today, however, the focus for sterling traders is likely to turn to the BoE, with a policy decision and Monetary Policy Report both set to be delivered at lunch time tomorrow. As noted above, we think it remains too early to confidently bet on the BoE turning dovish. If confirmed in tomorrow’s communications, this should see GBP retracing some of the week’s early losses.

CAD

Tuesday’s trading saw CAD struggle to pick-up support from dynamics that would ordinarily be loonie supportive. A midafternoon rally in oil prices coincided with a notable CAD slide, while a generally positive equities session and a modest trimming in yields also offered little upside impetus. While the upshot of all this was a close to half present rally in USDCAD, this price action looks instructive to us. As we see it, markets are increasingly aligning with both our bullish view for the pair, and our bearish view of the Canadian economy. Specifically, although net short loonie positions were trimmed last week (week ending April 30th), these are now most likely being rebuilt with local factors appearing unsupportive of fresh longs. Indeed, we think this could have further to run given that CAD OIS are still underpricing the BoC’s easing cycle relative to our base case. Markets continue to see just a 72% chance that the BoC cuts rates in June, and have only 2.6 rate cuts prices for this year as a whole. In contrast, we are anticipating not only a June rate cut, but likely, 2-3 rate cuts later this year as a continued slowdown in the domestic economy forces the BoC’s hand, even as the Fed delivers just 50bps of easing. This message could well be rammed home for markets on Friday too, with April jobs report set to be published. With the likely to show further signs of growing labour market slack, we think this warrants traders taking a cautious stance on CAD heading towards the end of the week, despite some loonie supportive cross-currents.

 

 

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