G10 FX volatility decreased significantly yesterday as markets started to take a wait-and-see approach ahead of today’s key risk event: the ECB policy announcement. Arguably, developments in the US are playing a secondary role this week, with markets mostly focused on European events (political, geopolitical and economic). Still, US housing data continued to show signs of weakness as mortgage rates rose. Given that this sector accounts for 2.5% of the US economy and that housing transactions have a high correlation with retail sales, expect recent grim housing numbers to further fan recession talk.
Canada's June CPI accelerated by less than expected and the market responded by slightly downgrading the chances of a 75 bp hike when Bank of Canada meets again on September 7. The market has gone from pricing in a 75 bp hike almost fully to about 80% chance. The decline in equities also did the Canadian dollar few favors, snapping a three-day advance. Canada reports May retail sales before the weekend and a strong gain is expected. Observe the USD/CAD chart.
European Central Bank will deliver its long-awaited first-rate hike today. The chances of a larger hike (50bp) appear to have risen after recent reports suggested this option was being seriously considered by the Governing Council. This leaves the euro vulnerable to some correction today in the event of a 25bp hike and may not receive very sustained support even in a 50bp scenario given the worsening macro picture. The balance of risks appears skewed to the downside for the euro with the potential re-testing of parity over the coming days.
Liz Truss and Rishi Sunak are heading to the run-off to replace Boris Johnson as UK prime minister. The two candidates will campaign for six weeks now, and markets will likely get a better idea of where they stand on the most sensitive points: fiscal support and relationships with the EU. For now, the impact on sterling should remain secondary to macro and monetary policy factors.
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