Today, Russia and Ukraine restart peace talks, and despite the lack of progress, markets continue to price in a higher likelihood of an impending de-escalation. As a result, the dollar is weakening, while previously battered European currencies are gaining ground. A comeback in the Chinese yuan, which has nearly recovered all of its losses since the start of the week on the basis of news that Saudi Arabia will consider taking yuan payments for crude it supplies to China, has also conspired against the dollar. The impact of today's FOMC rate announcement may be complicated in such a unique global scenario. Most expect a 25bp rate hike today, in line with recent communication by Fed Chair Jerome Powell and market expectations – which are only pricing in a 10% implied probability of a 50bp move.
Looking at the FX impact, we think the Fed message today should confirm that monetary policy is set to prove a medium-term positive for the dollar. That said, barring a major upside surprise, we suspect the post-FOMC impact on USD could prove rather contained and short-lived, leaving the dollar somewhat vulnerable to the current risk-on environment.
Yesterday, the USD/CAD broke decisively below 1.2800, assisted by some USD weakness but also signalling that the current drop in oil prices is insufficient to warrant substantial CAD weakening. Crude and other energy prices are still significantly higher than they were before to the Ukraine war, and they are expected to spur continued recovery in the Canadian oil and gas industry, which could help CAD in the long term. The February CPI report will be released today in Canada, with headline inflation projected to rise from 5.1 percent to 5.5 percent. We believe that this, combined with the Fed's start of the tightening cycle, will help to reinforce market expectations that the Bank of Canada will continue to raise interest rates at a reasonable pace (five to six more hikes this year), bolstering the loonie's positive momentum. Today, the USD/CAD is expected to re-test 1.2700.
The EUR/USD is still primarily influenced by market mood surrounding the Russia-Ukraine peace talks - domestic variables had no impact on the pair yesterday. There are no market-moving data releases in the eurozone today, and the post-FOMC FX impact could be minimal, giving EUR/USD another chance to break above 1.100. In the medium term, external geopolitical forces will continue to influence the euro.
There are no data releases scheduled for today in the United Kingdom, so the pound should continue to benefit from the cautious optimism surrounding military de-escalation in Ukraine. Unlike other European currencies, the GBP is struggling to recover from war-related losses. This could be due to a wait-and-see attitude ahead of the Bank of England meeting tomorrow, where a rate hike mixed with more hawkish language could allow the pound to catch up with the current market environment. GBP/USD should remain above 1.3000 for another session unless the FOMC surprises to the upside today.
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