With last week’s data setting the stage for another rate hike by the BoE next week, markets are likely to turn a blind eye to the UK’s economic releases this week, especially as they pertain to soft activity measures for January which are only expected to show a marginal uptick given the decline in Covid cases and marginal easing of restrictions. Today’s preliminary readings of January’s PMIs at 09:30 GMT are such an example of this. Instead, focus is going to sit squarely on the rate space and political developments. With the FOMC set to announce its latest policy assessment on Wednesday evening and focus resting heavily on balance sheet guidance, the dollar leg of GBPUSD is likely to provide the impetus for volatility, especially following last week’s global equity market developments. Meanwhile, events in the political space are set to determine the markets’ risk tolerance and could potentially see more of a political discount priced into the pound. Domestically, Prime Minister Johnson remains under substantial pressure to resign as the Gray report into breaches of lockdown measures by 10 Downing Street is set to be released this week, while geopolitical tensions rise as Russia continues to build up its presence at the Ukrainian border. Over the weekend, UK officials denounced former MP Yevhen Murayev as Putin’s choice to lead a puppet government in Ukraine should the current government be overthrown as NATO allies start to go public in order to foil Russia’s invasion into Ukraine, which the US deems “imminent”.
The euro has moderately weakened across the G10 currency board since Friday, with traders focusing on Italian elections today before turning to the Federal Reserve’s monetary policy decision on Wednesday. Some of the risks towards a weaker euro were cleared over the weekend after former Prime Minister Silvio Berlusconi withdrew. Current Prime Minister and former European Central Bank Chief Mario Draghi, who has been credited with restoring stability in Italian politics, is seen as the frontrunner in the elections, however, there is a risk of destabilising the government if he leaves his current role. If a smooth transition to a new prime minister is secured, however, Draghi’s win should be net positive for markets as he would be President throughout the entire duration of the EU Recovery and Resilience Plan, of which Italy is the biggest beneficiary. Beyond Italian politics, euro traders will focus on geopolitical tensions with Russia, especially if gas supply to Europe will be brought into play against potential sanctions. At the moment, this isn’t priced into the single currency, but it is a risk to the outlook. On the data front, Januari purchasing managers’ indices should show a continued decline as Omicron and higher prices have been weighing on sentiment, however, this should be of little to no importance to FX markets given the market impact of PMIs has been muted over the last year.
The US dollar is holding up well among major currencies ahead of Wednesday’s FOMC meeting where further confirmation of a March rate hike is expected, as markets have now fully priced in a 25bps rate hike at the end of the quarter. While Fed Chair Powell may stay clear of any explicit confirmations, markets will be on the lookout for any hawkish tones, which should arguably be more pronounced than the previous meeting as uncertainties around Omicron have diminished somewhat since the December meeting. At the same time, the unemployment rate declined further since then while annual inflation reached another 40-year high – although the price pressures were less broad-based across subcategories in the last report. Stronger, broad-based inflation has helped to lift the US dollar over the last quarter as this raised market expectations for the Fed to tighten policy. In December’s meeting, the Fed doubled the speed of its bond taper programme to have stimulus wound down in March completely compared to June previously. Wednesday’s meeting could see the central bank put a halt to its QE programme fully, which markets would take as a clear sign that March will be the time for lift-off. This would ultimately strengthen the dollar. In the absence of such an event, the dollar may grind lower post-Fed as it retraces gains made in the buildup to the FOMC meeting. Today’s calendar includes PMI data from the US, however, this is unlikely to change dollar sentiment.
After weeks of appreciation, the Canadian dollar finally slipped on Friday to reverse its gains over the week and sit 1.06% off recent highs. The decline in US stocks, drop in WTI from recent highs back to $85 per barrel, and jump higher in US front-end yields to above 1% were all responsible in the loonie’s decline. However, this morning, the Canadian dollar has firmed along with oil markets as the focus sits firmly on tensions in eastern Europe and the potential impact it could have on the commodity complex. JP Morgan analysts last week suggested that Brent, which trades at a slight premium to WTI, could jump to $150 per barrel in the coming two quarters should the Russia-Ukraine tensions result in an adverse geopolitical event. A mixture of sanctions and a unilateral supply cut by Russia in retaliation to imposed sanctions could see the global oil supply reduce by 2.3m barrels per day. While higher oil prices are likely to support a further rally in the loonie, the corresponding tightening of financial conditions to react to the inflationary shock and the downturn in global risk sentiment and growth projections could see the loonie weaken despite the rally in oil. For this reason, traders exposed to commodity currencies such as CAD will be keeping a close eye on geopolitical developments this week, while CAD traders specifically will be focusing on the BoC this Wednesday and its updated monetary policy report.