Inflation fears continued to rock equities yesterday, sending the S&P 500 into bear market territory and generating another flight to safety in global markets. This morning, European and US stock futures are trading in the green, signalling a potential pause in the sell-off after three terrible days for risk assets. In FX, the dollar has emerged as the clear winner in the current environment, trading somewhere between 2.1% and 4.7% higher against G10 currencies compared to last Tuesday. The dollar strength continues to be fuelled by a re-pricing higher in Fed rate expectations. Markets have rushed to rapidly price in a 75bp rate hike by the Fed tomorrow, now attaching a nearly 100% implied probability to this scenario. We acknowledge 75bp is looking increasingly likely and at this stage, it is not to be excluded that investors will continue to push their expectations even higher, and start considering a 100bp hike. The market-implied terminal rate for mid-2023 is now above 4.0%, having risen around 70bp since last Thursday (before the US CPI report).
The CAD is trading defensively against the strengthening USD. At the time of writing the USD/CAD is well north of 1.29. US/Canada yield spreads have narrowed, equities continue to get hammered and volatility in the market continues to rise – driving the loonie lower. Crude is about 2% lower as global growth concerns rise and China extends some Covid curb reimpositions. The CAD slide looks excessive from our point of view, given the strength of the domestic economy, the BoC’s own hawkish intent, and yield premiums over the USD for the CAD but that will not help the CAD resist the USD’s general advance for the moment. We look for the loonie to target 1.30.
The euro is somewhat less vulnerable than other pro-growth currencies to the current slump in global risk assets. Markets will remain reluctant to re-enter bullish EUR/USD positions despite the seemingly attractive levels given: a) the support to the dollar offered by the sharply rising hawkish bets on Fed tightening and b) the significant widening in the eurozone’s peripheral spreads. Today, the German ZEW will be watched closely as the consensus expects some improvement in both the expectations and current situation surveys. This is unlikely to materially mitigate the market’s concerns about the upcoming slowdown in the eurozone economy, but may help EUR/USD climb back to 1.0500 if risk sentiment stabilizes.
The Brexit factor is about to re-emerge for the GBP, as PM Boris Johnson published a plan yesterday to give ministers the power to unilaterally suspend parts of the Northern Ireland Protocol between the UK and the EU. Such a move would most likely trigger an automatic retaliation by the EU in the form of tariffs and other export duties. This is likely to exacerbate the ongoing bad momentum for the GBP. On the data side, UK jobs data showed a slight increase in the unemployment rate and a flattening of wage growth as the UK labour market undoubtedly remains tight. We see predominantly downside risks for GBP as the BoE announces policy on Thursday.
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