News & Analysis

GBP

The pound struggled to hold onto Wednesday’s gains in yesterday’s trading as the afternoon session saw the broad dollar return with fresh legs. The decline in the euro following the ECB meeting was likely the catalyst that got the dollar up and running again against European currencies, while signs that both Russia and Ukraine are still some distance apart with their respective demands for peace following discussions in Turkey offered little support as well. The two dynamics prompted fresh selling in European equities and currencies, while the ECB decision likely acted as a precursor for markets for next week’s Bank of England and Federal Reserve meetings. That is, hawkish bets on policy tightening in the near-term are likely to be overexaggerated as central banks return to a cautious risk management mode given the increased level of uncertainty in the global economy. While we think the Bank of England will continue to hike by 25bps at next week’s meeting, which should provide a modicum of support to the pound, especially against the euro, we think the Bank will ditch any forward guidance on future tightening given the current level of uncertainty. This view of “small steps in the dark”, as former ECB President Draghi put it back in 2019, is soon becoming the consensus call among economists. Indicative of this, Goldman Sachs, one of the more hawkish banks on the sell-side, recently moved their call to envisage a pause in the Bank’s hiking cycle at May’s meeting from back-to-back rate hikes. This morning, the pound is still trading at the mercy of the broad dollar as risk sentiment continues to shift. The pound’s vulnerability to broader conditions is still visible despite this morning’s strong beat in UK GDP, which came in at 0.8% MoM compared with expectations of just a 0.1% gain. The data highlights the strong sequential growth in the UK economy as it exits the Omicron wave, with consumer-facing services leading gains by 1.7% MoM following a 0.2% contraction in December. With Omicron cases still high in January, some of the rebound in growth likely spilt over into February. But given the incoming hit to real household incomes and the impact of the Ukraine war on business and consumer sentiment, we expect Q1’s growth figures to include the strongest monthly expansions this year. At 09:30 GMT, the BoE/Kantar inflation expectations data is released, which will provide instrumental for the BoE’s upcoming decisions. Despite the increasing risks to the growth outlook, the Bank will likely continue its hiking cycle should medium-term inflation expectations start to unanchor from target.

EUR

Despite yesterday’s rather hawkish European Central Bank decision, the euro pared back all of its post-statement gains as dovish undertones shined through the press conference. The rate statement outlined how the ECB is increasing the tapering pace of its asset purchase programme (APP) such that bond-buying would potentially end in Q3 as opposed to Q4 previously. At the same time, the central bank removed the phrase that stated rates could be moved either way, as the ECB slowly lays the groundwork to start raising interest rates this year or next. On balance, the central bank’s decision was more hawkish than market participants had expected, as most expected the ECB to hold more of a wait-and-see approach until the uncertainties around Russia-Ukraine had subdued, but concerns about growth eventually led to the turnaround in markets: 10-year Italian bonds (BTPs) dropped like a stone on the prospect of less ECB support and lower growth, while EURUSD fell to fresh session lows.  President Lagarde referenced the risk of the inflation and growth outlooks changing given the uncertainties at the moment and added the relevant caveats that policy remains flexible and can be adjusted under certain scenarios. Minor tweaks to the timing of rate hikes following the end of the QE programme also provided some dovish pushback as the ECB moved from stating that rates would rise “shortly after” net purchases ended to “some time after”. Today, all eyes will be on discussions in Versailles as EU leaders seek to gain a consensus on supranational bond issuance to finance investment in energy infrastructure to become more self-sufficient in the future.

USD

The US dollar is headed for its third consecutive week of gains as safe haven demand remains strong while Russia-Ukraine talks fail to be yielding much progress. US President Joe Biden is set to call today for an end to normal trade relations with Russia and may be imposing increased tariffs on Russian imports, according to reports. On top of this, the Senate passed a full-year $1.5trn federal funding bill that wards off a possible government shutdown while part of it will also be used to provide Ukraine with aid to respond to Russia’s invasion. In terms of data, yesterday’s US CPI from February was a dud event for markets. The headline figure printed at 7.9% YoY, exactly matching economists’ expectations to hit a 40-year high, but the print was outdated in the eyes of FX traders given the recent surge in global commodity prices. The data should keep the Fed on track to hike rates by 25bps at next week’s meeting.

CAD

The loonie rose more than a quarter of a percent against the greenback on Thursday. The move in CAD was rather disconnected relative to its trading patterns thus far this week as it coincided with North American equities trading lower, with the S&P 500 closing 0.43% lower on the day, and energy prices also down on the day with WTI 2.5% lower and gas oil down 17%. Meanwhile, the fear index, VIX, was down almost 7% from yesterday but still above 30, a sign of continued risk-off sentiment. The more aggressive sell-off in Canadian bonds relative to US Treasuries may have provided some impetus for CAD to strengthen, but analysts mostly pointed to expectations that Canada will step up as an energy producer to fill the gap left by disruptions to Russian oil supply as the reason for the loonie’s rally. This reasoning is plausible, especially considering the stock prices of major Canadian oil & gas producers Enbridge and Suncor both rose today despite the pullback in WTI, but it may be too soon to draw such inferences as commodity markets are still adjusting to the shifting demand and supply conditions. Today, at 13:30 GMT, markets will get an update on the status of the Canadian labour market, which by all accounts is expected to show employment rose by 127.5k. This wouldn’t see January’s Omicron induced job losses of 200.1k completely reverse, but it will still likely confirm expectations of continued policy tightening by the BoC if the data prints in line with expectations.

 

 

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