News & Analysis

USD

The dollar DXY index rallied close to a percent last week even as the risk of the Fed turning more hawkish on this year’s rate path never materialised. While three rate cuts were still projected for the year, the Fed signalled a higher path for rates from 2025 onwards, a stance that soon became hawkish in the grand scheme of things as European central banks either cut rates, in the case of the SNB, or progressively began to move in that direction on Thursday. The dollar received another tailwind on Friday from Asia, where a weaker CNY fixing coincided with a market focused on higher intermediate Treasury yields and a raft of disappointing local earnings data, leading USDCNY to break through the 7.2 cap that had been in place for much of this year in a move that triggered smoothing measures from authorities.

Following Friday’s surprising move in the yuan, the focus this morning was on China and whether authorities would push back on market forces and publish the daily fix back below 7.10 or maintain a weaker fixing rate in a move that would suggest a new regime of managed depreciation. At 7.0996, the fixing was on the stronger side. In fact, the countercyclical factor (the spread between the model implied fix and the actual outturn) was the widest since early November when authorities were defending the yuan at the 7.30 ceiling. With the threat of this being supplemented with quasi-intervention or a liquidity drain to make funding conditions of CNY shorts more punitive, traders soon adjusted their positions, leaving USDCNY to trade back to the 7.20 handle this morning.

Given recent developments in China and the ongoing threat of stealth intervention in Japan after the yen weakened back towards multi-decade lows following Tuesday’s BoJ decision, Asian FX is likely to remain in the limelight this week. Whether authorities do intervene or ultimately allow their currencies to weaken in a managed fashion will be crucial for FX markets as a whole seeing as quasi-pegs in CNY and JPY have anchored volatility in Asian FX in recent months, making the region an attractive source of funding for the popular carry trades. This question may be answered ahead of Wednesday should US yields continue to drift higher, but if not, Fed Governor Waller’s speech at 10pm GMT will take on added significance, especially as his views have largely been representative of the core narrative within the FOMC. Should Waller sound more concerned than Powell last week on the recent strength in US data, yields are likely to break higher, placing Asian FX under greater pressure. Waller isn’t the only risk factor this week, however. Chair Powell takes to the wires again on Friday at 15:30 GMT, shortly after February’s PCE report is released. With this occurring in thinner liquidity conditions due to market holidays in most of Europe, its impact could be amplified too.

EUR

The single currency’s tenure above the 1.09 handle proved short-lived, as weaker wage and PMI data last week coincided with another wave of broad USD strength to send EURUSD seven tenths of a percent lower on the week. That said, the euro continued to outperform peers in this environment as markets remained reluctant to bet against the ECB’s guidance and price a greater chance of an April cut.  As we have noted since the ECB meeting earlier in the month, while this provides the euro with some short-term support, it only delays the pain as ultimately eurozone data should signal that policy was kept too high for too long. Whether this remains the case this week will largely depend on March’s flash inflation reports. The last before the ECB’s April decision, the data will be crucial in determining whether the ECB can maintain its narrative of a June cut or whether the doves will ultimately have their way to the markets surprise.

Elsewhere in Europe, this week also sees the Riksbank take to the stage. With inflation conditions markedly improving, Swedish policymakers are likely to sound dovish, joining the European chorus from last week. This could see EURSEK track higher to 11.5, but we suspect these levels will prove unsustainable given eventual ECB easing in Q2.

GBP

A busy last week saw sterling soften 1% against the dollar 0.35pp against the euro, a move in large part driven by some surprising dovishness from the BoE. Not only was commentary accompanying Thursday’s decision much more open to the prospect of rate cuts than many had expected, but subsequent comments from Governor Bailey also served to reinforce this message. We remain sceptical, however. Despite the Governor’s insistence that “all our meetings are in play”, we see little chance that the MPC will actually feel comfortable easing at the next policy meeting in May. Only one more round of CPI and wage data is due before the May meeting, and we strongly doubt that this could offer enough evidence for the MPC to justify a cut to Bank Rate. Given this, market pricing that now sees the odds of a May rate cut at more than 30% looks stretched to us, as does the 85% implied probability of a first rate cut being delivered by June. We continue to see August as the most likely timing for the first cut to Bank Rate. In our view this is the first meeting where the MPC will have seen the full impact of April’s National Living wage rise in the data, though admittedly, there are increasing risks that the BoE moves in June if the BoE receives multiple rounds of benign readings. Even so, we expect markets are likely to find that the BoE is ultimately more hawkish than currently priced, so whilst policy expectations are weighing on sterling for the time being, this is unlikely to last. A quiet week before the Easter weekend is unlikely to be the trigger for a reassessment of easing expectations that lead the pound higher, however. With little market moving data scheduled for release, sterling’s recovery will likely have to wait for April.

CAD

Even in spite of the BoC’s hawkishness, USDCAD continues to flirt with year-to-date highs. As we have previously noted, we think the loonie should be trading softer against the dollar in light of fundamentals, meaning that we are inclined to view risks heading into this week as skewed towards an upside break in the trading range. On the US side of this equation, this hangs on the risks of Fed speakers sounding more hawkish than Chair Powell this week. In Canada, however, two notable data releases will be in focus. Namely, January’s SEPH employment reading, and a GDP print for the same month, with both set to be published on Thursday. Further signs that the Canadian economy is continuing to struggle under the weight of overly tight policy should see BoC easing bets accelerate, weighing on the loonie. Indeed, at just 22%, the odds of an April rate cut look underpriced to us, as does the 84% chance of a cut by June. In our view, the BoC should cut in April, and will cut by June. If the data further supports this view, it should see market bets on BoC easing rise, providing a catalyst for USDCAD to break to the upside to levels not seen since November.

 

 

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