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FX Markets Trade with Cautious Optimism that the Fed will Ease Interest Rates in 2023

USD - US Dollar

Risk assets have started the year on strong footing with good performances from both equity and debt markets. This comes at a time when the market is growing increasingly confident that the Fed will end its tightening cycle this quarter and embark on an easing cycle in the third quarter. Today will see two inputs into that Fed story in the form of:

i) Comments from Fed Chair Jerome Powell

ii) The NFIB small business sentiment survey. The market does not seem to be buying into the Fed's narrative of the funds rate being taken to 5.00% and being kept there for a long time. For now the markets seem to be pricing a 50bp easing cycle in 2H23. Thursday's US CPI will also be a key data point that will provide short-term direction on the greenback.

CAD - Canadian Dollar

Follow-through Canadian dollar buying after strong employment data at the end of last week, greater confidence that the Bank of Canada will hike later this month, and the initial gains in US equities saw the USD get crushed in yesterday’s trading. USD/CAD fell to 1.3355, its lowest level since late November. It is little changed now in a tight range straddling 1.34. US equities should provide direction cues for the pair today.

EUR - Euro

EUR/USD managed to nudge up to a new high yesterday without the support of any major news. European equities continue to outperform at the start of the year and eurozone data also continues to surprise on the upside. For the time being, we would prefer to back further EUR/USD strength – should today's US event risks allow. This could see EUR/USD pressing last May's high at 1.0785. This week there is an outside risk of 1.0950 should Thursday's US December CPI show another soft reading.

GBP - British Pound

The GBP has been performing slightly better, helped by the positive risk environment to start 2023. The pound barely budged yesterday on comments from Bank of England Chief Economist Huw Pill that there were early signs that the UK labour market was softening. Market pricing of a further 100bp BoE hike to the 4.50% area this summer looks firm. GBP/USD could have some more upside should US data allow.

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