Yesterday’s semi-annual Senate testimony by Federal Reserve Chair Jerome Powell surprised on the hawkish side and triggered a large dollar rally. Powell hinted both at a higher peak rate ( “that the ultimate level of interest rates is likely to be higher than previously anticipated”) and opened the door for a return to 50bp hikes (“we would be prepared to increase the pace of rate hikes”). This marked another key step in a month-long process of re-pricing rate expectations after the February FOMC press conference had led markets to bet on an early end to the tightening cycle. The question now is, can the Fed continue to push the dollar higher? The short answer is yes, essentially because even assuming markets won’t price in a higher peak rate than the current 5.75%, a 50bp move in March isn’t fully priced in (40bp embedded in the OIS curve) and there is ample room to scale back rate cut expectations for end 2023 and early 2024. Over the next few days volatility should remain elevated, and the dollar’s balance of risks is moderately tilted to the upside ahead of Friday’s jobs numbers. Today, we have the second round of Powell’s testimony (to the House) and the release of the Fed’s Beige Book. On the data front, ADP jobs figures will be published. Look for the USD to remain well supported.
The Bank of Canada announces monetary policy today, and is widely expected to keep rates unchanged. The “pause” narrative was recently endorsed by disappointing growth and slower-than-expected inflation. However, the jobs market has remained tight, and data show that there are over 800k more employees in Canada than before the pandemic. Some cooling off in the jobs market will likely be required to make the BoC relaxed with some re-easing of financial conditions, and for now, it’s likely that Governor Tiff Macklem wants to keep the door open for more tightening if needed, also because inflation remains significantly above target. We continue to expect a return to 1.3000 by the second half of the year, but that would almost solely be a matter of improved risk sentiment and a weaker USD, rather than a stand-out CAD outperformance. Observe the USD/CAD trends.
The Powell-led EUR/USD drop yesterday means that the next key support for the pair is now 1.0500. That is a key benchmark level for the pair, and the elevated volatility – combined with deteriorating risk sentiment - raises the chances of a break lower. Such a break lower would however continue to mirror primarily dollar strength as opposed to a lack of faith in the euro’s fundamentals. The euro is the best-performing G10 currency after the dollar in the past month, and we doubt fresh idiosyncratic EUR weakness is on the cards. The European Central Bank continues to propel rate expectations higher, and the recent inflation readings give President Christine Lagarde all the incentive to sound hawkish when she delivers another 50bp hike next week. Incidentally, the latest PMIs have been pointing to an improved eurozone outlook. Today and tomorrow will offer the best opportunity – in our view – to press below 1.0500, while we favor a EUR/USD rebound on a softer US jobs report on Friday.
GBP faces upside risks every time the Fed’s hawkish messaging hits risk sentiment: this is because the pound has a higher sensitivity to risk sentiment. The pound is lacking internal drivers this week and is likely to take cues from broader market themes.
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