FX markets are slightly calmer this morning as the world tries to come to terms with war in Europe. The dollar strengthened through the day yesterday amidst signs of some stress in dollar funding markets. The fallout from the Russian sanctions for global financial markets may take some time to percolate. Given the uncertainty, we suspect investors will want to hold on tight to their dollars. Also helping the dollar seems to be the Federal Reserve story, where FOMC members still seem happy to speculate over a 25bp or 50bp rate hike at the 16 March meeting.
Away from Ukraine, the US macro data will focus on personal income and inflation data. Here, the core PCE deflator is expected to rise to 5.2% year-on-year in January - probably keeping the debate going over whether the Fed hikes 25bp or 50bp next month. We continue to favour the dollar over Europe over the medium term.
The sell-off in CAD continues to reflect the jump in the VIX and tumble in global stocks but even with a losses, the CAD is holding up relatively well among the majors. Higher commodity prices—and the potential for prices of key commodities to continue rising while the conflict and uncertainty persist will provide support on the CAD, but the risk backdrop will remain the primary driver for the CAD which means the CAD is liable to trade with a softer tone in the short term. The market pricing for next week’s BoC policy decision has not changed and continues to reflect a strong probability of a 50bps move. observe the USD/CAD Chart.
We may not know for a day or two, but most suspect the size of Central Bank of Russia FX intervention yesterday was very large - perhaps in the region of US$5-10bn, This intervention would have been to supply FX, mainly USD, to the local market and to prevent the rouble from collapsing any further. That activity will leave the FX composition of reserves overly balanced to euros, meaning it would now be a surprise to hear of the CBR selling EUR/USD in the spot market to rebalance reserves. This sizable re-balancing could add to pressure on EUR/USD. We now favour this trading in a broad 1.11-1.13 range and will look out for any further ECB commentary on whether events in Ukraine will delay the central bank's exit from stimulus.
GBP has actually performed quite well given the heavy sell-off in European equities yesterday. UK equities are heavily exposed to the Oil and Gas sector, which understandably has come under a lot of pressure given links to Russia. The surge in European gas prices probably means that UK CPI peaks closer to 8% than 7% and will stay higher for longer. That should keep the BoE wary and should market conditions calm - and the focus return to macro-tightening and interest rate hikes.
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