Many UK watchers may be wondering why even come into the office this week, with an incredibly light data calendar, and little in the way of political drama on the horizon to move markets. This sentiment certainly seems to hold true for sterling this morning, having begun the week down 0.2pp against the dollar and flat against the euro. For those that do make it in, however, it is central bank speakers that are likely to be the centre of attention. Following the recent decision to raise the Bank Rate by 25bp, speculation is now beginning to focus on whether or not this marks the end of the BoE’s hiking cycle. In our view it does, but more clarity should be provided by BoE Chief Economist Huw Pill who speaks at 17:30 BST tomorrow, sandwiched between two talks by external MPC member Silvana Tenreyro, speaking at 10:15 BST earlier that day and then again at the same time on Wednesday. With Tenreyro well established as the most dovish member of the MPC, her comments are unlikely to move the needle as far as markets are concerned. But Pill’s views on the other hand will be a good guide as to the thinking of the MPC’s central voting bloc. In particular, markets will be paying attention to any comments regarding the evolution of inflationary pressures, and the extent to which financial stability concerns are weighing on the UK economy. Notably, given that house prices showed a greater than expected -3.1% decline year on year in last week’s data release, it will be interesting to see if this is commented on by Pill. With the direction of travel pointing downwards in the near term, the state of the UK housing market and associated financial stability risks do seem likely to become a focus for both markets and policymakers as the next few months progress.
The single currency climbed 0.8% over the course of the past week as the still-hawkish message from the ECB prompted rate differentials between the eurozone and the US to narrow further as risk conditions were legally supported by the absence of negative news on banks. However, this morning, the slow and steady euro appreciation has hit a stumbling block as the OPEC news has prompted support for the dollar, likely due to the impact this will have on inflation projections around the world and the risk that higher rates could spark further financial instability. Without any notable speakers from the ECB and economic data scheduled for release today, the path higher for the euro is likely to remain temporarily blocked.
Data released at the back-end of last week highlighted how contagion in the US banking sector has largely been stemmed and why in the absence of any sharp gyrations in regional bank stocks, the risk backdrop in markets had been supported throughout the week. Both data on the composition of the Fed’s reserves and overall bank deposits, lagged by half and one and a half weeks respectively, showed that the uptake of the Fed’s liquidity provisions had fallen and that overall deposit flight out of US banks into mutual money funds had slowed considerably. While the situation on the liquidity side of the banks’ balance sheets is looking more robust, markets still remain concerned about what this means in terms of effective credit tightening. With this in mind, there remained a level of hesitation in the rates market to remove the bias towards policy easing from the Fed in the second half of the year, despite rate expectations reflating across interest rate swaps for developed markets. At the end of the week, the December OIS strip still implied just over two rate cuts from the May meeting, down just 17.7bps from the previous week’s close. The narrowing in rate differentials with key G10 partners was a key catalyst for the dollar’s depreciation last week.
This week, focus will remain on pricing of the Fed as markets are still somewhat blind when it comes to the extent in which credit conditions have effectively tightened. With the answer unlikely to be forthcoming without US policymakers relaying their proprietary information or the publication of the Fed’s Senior Loan Officer Opinion Survey, which isn’t due for release before the Fed’s next meeting, the release of data on the US’s economic fundamentals may be overshadowed and the cross-asset backdrop of risk being supported but Fed expectations lagging in G10 swaps could persist. That said, there is a scenario where the outturn of US data forces the question for markets, especially if Friday’s payrolls data follows the recent trend and substantially exceeds consensus expectations. The reaction in markets to such an event will be crucial for determining what the overall perception is of investing in the US economy and whether, similar to the UK after the fallout from the mini-budget in the Gilt market, investors are quick to discount the potential returns due to the level of risk that remains.
Traders haven’t had to wait until the US data calendar kicks into gear towards the end of the week to start speculating on the Fed’s next steps, however, as the surprising intermeeting announcement from OPEC+ over the weekend to cut the production of oil by 1.1m barrels per day has spurred concerns over inflation persistence yet again and boosted front-end bond yields across core markets. This has given the dollar a temporary boost overnight, with the Japanese yen and the New Zealand dollar leading losses in the G10 due to their sensitivity to US rates. However, we think the level of support for the greenback will be limited from this dynamic, especially as traders remain hesitant to really buy back into the Fed’s “higher for longer” message.
The Canadian dollar capped last week off as the best performing G10 currency against the US dollar, closing the week 1.7% higher. Helping to sustain its recent rally into the weekend was stronger-than-expected GDP data for January. Printing at 0.5% MoM and with growth in 17 out of 20 measured industries, the reacceleration in the pace of Canadian economic growth weighed on pricing of rate cuts from the BoC this year, with the December overnight index swap now factoring just 42bps of cuts, down 25bps on the week. This was not only driven by a similar but less dramatic repricing in US interest rate expectations, but also by the GDP data because a lot of emphasis from the BoC on rebalancing the economy prior had been placed on a stagnant growth profile in 2023. We think this dynamic has further to run, especially as StatsCan’s preliminary estimate for GDP in February sees further expansion in the economy at 0.2% MoM. While traders await the BoC’s business outlook survey at 15:30 BST/ 10:20 ET for further signs on the Canadian growth profile, the loonie hasn’t stopped its surge higher as it joins the Norwegian krone in climbing against the dollar as WTI trades 5.4% higher and close to $80 per barrel on news of OPEC’s surprise production cut. For now, it seems all of the pieces are falling into line for those bullish on the Canadian dollar.