The dollar's upward potential appears to be heavily reliant on the market's willingness to price in the Fed funds rate above 1.50-1.60 percent in the coming years. While hard evidence on the Omicron impact will be available in the coming days, yesterday's ADP employment numbers were robust, and fresh hawkish indications from the December FOMC minutes pushed tightening expectations higher. Members of the Fed appeared to support a rapid pace of rate hikes, as well as the potential of starting balance-sheet reduction as early as this year.
The dollar jumped after the minutes were released, and the minutes' hawkish tone should continue to support the dollar into today's session, though the fact that Omicron was not as severe as it is now around the December FOMC meeting may prevent further aggressive pricing of hikes – at least until data confirms the strong US growth story. Nonfarm payrolls on Friday will be crucial. Today, we'll look at the December ISM services survey, which is widely predicted to have dropped owing to Omicron.
CAD came under pressure after the FoMC minutes were even more hawkish than expected, with regards to the balance sheet normalization. This saw stocks under pressure and the USD/CAD move higher toward the high 1.27s. It is interesting to note that some Fed members suggested tightening financial conditions via the balance sheet rather than rate hikes, which suggests the move may be a little overdone. But a hawkish Fed won’t go unnoticed by the BoC and therefore in the bigger picture, CAD should continue to perform well against most of the G10. Given the probability of very rapid BoC tightening this year, most analysts remain upbeat about the CAD outlook.
A rally in EUR/USD was reversed after the hawkish Fed minutes, and the pair is back around 1.1300 this morning. Today's market attention will be on Germany's December CPI figures. The consensus is for the headline figure to fall from 5.2 percent to 5.1 percent YoY, confirming concerns that eurozone inflation has already peaked — with Omicron closures now causing some pressure. Most analysts doubt that this will have an immediate impact on the EUR, given that the European Central Bank's path looks to be determined for the time being following the detailed advice offered at the December meeting. In the long run, the Fed-ECB policy divergence will keep the EUR/USD at a negative level for the majority of 2022.
The GBP was a strong performer at the start of the year is giving up some gains as risk sentiment deteriorates. Dollar gains may push GBP/USD down below 1.3500 today. On the domestic front, the UK data calendar is rather quiet, with the government's efforts against Omicron retaining considerable attention. Boris Johnson's government appears to be trying to get through the Omicron crisis with minimal limitations, as evidenced by yesterday's decision to relax travel restrictions. Once risk sentiment has steadied, the pound should be able to maintain its support.