Markets have continued to scale back the Fed’s tightening expectations after Tuesday’s US CPI numbers seemed to indicate inflation may have peaked. The discussion does not concern the Fed’s next moves this year, as markets continue to price in back-to-back 50bp hikes into the summer and around 200bp of total tightening by year-end. Instead, investors seem no longer comfortable with the notion of a terminal rate at or slightly above 3.00% and have scaled their expectations back to the 2.75% area. Markets are now probably embedding a rather fast descent in US inflation. Supply-chain bottlenecks still suggest that descent will likely be long and slow, and ultimately should continue to advocate in favor of the Fed bringing rates to the 3.00% mark. In FX, this means that the dollar’s softish momentum may not have long legs, and the prospect of 50bp increases in May and June should also contribute to keeping the greenback in demand in the coming weeks. Today, the main focus in the US will be on the University of Michigan surveys as well as March retail sales and a few Fed speakers (Williams, Mester and Harker).
CAD - Canadian Dollar
As expected, the BoC doubled down tightening yesterday by delivering a bigger 50bp rate hike (to 1.00%) and announcing the start of Quantitative Tightening In its new Monetary Policy Report, the bank acknowledged that both growth and inflation have recently proved frothier domestically, as they lift their 2022 GDP forecasts (from 4.0% to 4.2%) and inflation profile (Canada’s CPI is only expected to cool to 4.5% YoY at the turn of the year, vs 3.0% previously). Against this backdrop, the BoC also raised its assessment of the Canadian output gap as the economy is moving to excess demand. Interestingly too, the BoC revised its neutral rate estimates with a 25bp increase compared to April 2021, to 2.00/3.00%. Although a minority of market participants only expected a 25bp move, the CAD just went to recoup marginal ground vs the USD. Perhaps more importantly for the long-term CAD outlook is that the BoC has upgraded its growth forecasts for this year, and to a lesser extent raised slightly its neutral rate assessment. Ultimately, the fact that the BoC and the Fed are seen as tightening largely hand in hand throughout this cycle is unlikely to offer the CAD a differentiating factor vs the USD. However, we continue to believe that the CAD is yet to fully reap the benefits of the positive terms of trade shock, as we retain a constructive CAD view mid to long term.
EUR - Euro
EUR/USD has climbed back above 1.0900 ahead of today’s ECB policy meeting. However, the move did not seem to mirror an increase in hawkish bets on ECB policy but rather followed EUR-USD short-term rate differentials purely driven by a re-pricing of the Fed’s rate expectations. Ahead of today’s meeting, we look at different options for the ECB to give some clarity on the policy outlook based on their risk assessment for inflation and growth. Most of the focus will be on any implicit rate guidance, any tweaks to the notion of sequencing (hikes only after the end of quantitative easing) and the details of further net purchases under the Asset Purchase Programme (APP). Most suggest that the ECB will fall short of the market’s expectations around a hawkish tilt in the message, as the uncertainty about the development and economic implications of the Ukraine conflict should encourage policymakers to keep their options open. This may translate into a weaker euro, which is still looking at an unsupportive external environment due to uncertainty around the French elections and the Russia-Ukraine conflict. EUR/USD may slide back towards the 1.0800 mark today.
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