As widely expected, the Federal Reserve doubled the pace of its tapering yesterday. The biggest news for markets was the substantial upgrade in projections, which are now signalling three rate hikes next year, followed by an additional three in 2023 and two in 2024. This clearly marks a full shift in focus to inflation forcing the FOMC to turn a blind eye to Omicron-related risks to the outlook. In FX, all this reinforces our view of a strong dollar in 2022 should mark a further widening in the monetary policy outlook between the US and the eurozone. Look for the greenback to reverse its mild losses yesterday and continue to remain supported in the medium term.
The CAD can’t seem to maintain any support. Weaker crude, a more aggressive Fed and the narrowing in US/Canada spreads are combining to drive the CAD lower. While the loonie did recover losses after trading north of 1.29 vs the USD yesterday, most expect the USD/CAD to continue to retain a soft undertone until the New Year. Don’t rule out another attempt at 1.29 over the next few days especially if Omicron-related news continues to dominate headlines.
Expect a dovish message by the ECB today. The Omicron variant is postponing any discussion on monetary tightening to a much later stage, and the focus is instead set to be on the future of asset purchase programs. Expect the EUR reaction to be negative as this week’s meeting should further highlight the Fed-ECB divergence on inflation views and policy direction: this should all keep EUR/USD capped in the medium term. For today, we expect the mix of the market reversing yesterday’s losses in the dollar and EUR weakness to put pressure on the 1.1200 support.
Most analysts see only moderate downside risks for GBP from a “hold” decision by the Bank of England today, given that markets have now priced out the option of a hike. When it comes to forward-looking language, the committee will highlight rising downside risks to the outlook but reiterate that rates will need to be raised next year. This should implicitly leave the door open to a February hike and should ultimately limit the pound’s losses. The 1.3200 support in GBP/USD may come under heavy pressure today.
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