Only yesterday morning, the market had just finally priced in a full 75bp rate hike in July for the first time. In a few hours, an above-consensus US CPI reading (headline inflation jumped to 9.1%) and a surprise 100bp rate hike by the Bank of Canada changed the whole picture again. After these two events, markets have moved to seriously consider a 1.0% rate increase by the Fed in two weeks. The CPI acceleration was certainly above consensus, but markets were already bracing for a headline rate acceleration and price pressure is expected to ease in July due to gasoline price contraction. Our call is still for a 75bp hike this month. However, the risk is that the market itself pushes the Fed to hike by 100bp, as some FOMC members may oppose the idea of a dovish surprise.
In all this, the dollar was on a roller coaster ride yesterday and volatility around EUR/USD parity (which was hit yesterday) should continue to be elevated and to impact other USD crosses. We think that the current re-pricing higher in Fed rate expectations can – along with other factors – keep the dollar supported and possibly strengthen across the board. Today, PPI data will be watched in the US.
CAD - Canadian Dollar
The Bank of Canada surprised markets and economists’ consensus by delivering a 100bp rate hike yesterday. In its statement, the Bank highlighted the breadth of price pressure – "More than half of the components that make up the CPI are now rising by more than 5%" – and the surge in inflation expectations – "more consumers and businesses are expecting inflation to be higher for longer". Market pricing seems to suggest investors are expecting more front-loading, with a 75bp move in September, followed by a 50bp move in October. Looking at the FX implications, we think that the BoC’s faster hiking could help the currency in the longer run but for now, external factors (eg, global risk sentiment, oil prices) continue to play a much bigger role and may keep CAD gains capped in the near-term. The chances of USD/CAD moving back below 1.25 by year-end (barring a prolonged USD strength) seems quite reasonable.
EUR - Euro
Yesterday, US CPI numbers pushed EUR/USD 2 pips below parity. That was followed by an immediate rebound which sent the pair back above 1.0100. EUR/USD is trading at 1.0017 at the time of writing. As discussed in the dollar section above, the potential re-pricing higher in Fed rate expectations is another element of downside risk for EUR/USD, along with the already negative macro picture and the growing risk premium related to the Russia-EU spat on gas supply. Another attempt at breaking below 1.0000 appears likely over the coming sessions, and this time we could see a more decisive move lower. We continue to see 0.9800-0.9900 as a potential short-term bottom for EUR/USD.
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