After a positioning-led rally in risk assets over the last six weeks, financial markets seem to be settling back into a macro-led environment where the 2023 global slowdown is front and centre. Brent crude is dipping sub $80/bbl despite the OPEC+ supply cut, bonds are rallying and equities are starting to hand back some of their impressive rally from October lows. The main threat the bullish dollar view comes from the risk of any softer US November price data (PPI released tomorrow, CPI next Tuesday) or a more positive re-assessment of Chinese growth prospects on the back of relaxed Covid measures. However, poor Chinese trade data released overnight serves as a reminder that the export environment will remain exceptionally challenging for China into 2023.
The Bank of Canada (BoC) will announce monetary policy today. The consensus is split between a 25bp and 50bp hike, but we believe a half-point move looks more appropriate given strong economic activity and a very tight labour market. Still, we admit it is a very close call given that the expected economic slowdown and fragility of the Canadian housing market argue for a smaller rate increase. Markets are pricing in 35bp for this meeting, so slightly leaning in favour of a quarter-point hike: in our base-case 50bp scenario, the Canadian dollar should rally on the back of the hawkish surprise. However, we don’t see the BoC impact on CAD to be very long-lasting, as external factors remain more important. A sustained recovery in CAD from these levels undoubtedly requires a rebound or at least a stabilization in oil prices. Today, USD/CAD could trade back below 1.3600, but short-term upside risks remain high.
It has felt like EUR/USD trading has become more settled over the last week, yet one week and one month realized EUR/USD volatility are still above 13%. This could be a precursor to one of the main themes of 2023, one of less trend and more volatility in FX markets. There is a case that last week's 1.0595 print was the corrective high in EUR/USD - we should know a lot more by next Wednesday evening after the FOMC meeting - and it will be interesting to see what the European Central Bank has to say on the 15th. For today, EUR/USD could drift down to 1.0400 in quiet markets.
Trading conditions have settled down for sterling where one-month traded volatility is pretty steady in the 12-13% area having traded above 20% in late September. If we are turning to a more macro-led trading environment, then GBP should underperform. A Fed staying hawkish into a recession should see equity markets come under renewed pressure. Typically, this is a negative environment for GBP, where the UK's large current account deficit is penalized. GBP/USD has turned from a strong resistance level at 1.23 and our bias into next week would be for a return to the 1.19 area.