If the early year dollar weakness had been driven by the search for value outside of US asset markets, then rising tension in eastern Ukraine and the accelerated correction in global equity markets might just reverse those flows as investor preference for dollar liquidity grows. What is clear is that rising geo-political risk and the ongoing re-assessment of growth stocks have very much started to weigh on currencies.
In the short term, we expect investors to play it safe and favor the dollar for liquidity purposes. European currencies whose economies have greater exposures to Russian natural gas imports presumably remain more vulnerable. For now expect the USD to continue to dominate with bigger moves to come after the Fed tomorrow evening.
There was no hiding place for the loonie yesterday, which broke above resistance at 1.2600/25 and traded at 1.2700, before funding some support as U.S. equities rallied 4% from the lows. We expect further volatility today as markets continue to price in geopolitical risk. Domestically, most expect the BoC policy decision tomorrow to result in a 1/4 point tightening in monetary policy, the first in a series of rate hikes aimed at getting inflation and inflation expectations back under control. We expect tomorrow’s policy meeting outcome to signal a hike which will effectively mark the start of a series of rate increases in Canada which takes the Overnight Target Rate to 2% by the end of the year. Higher short-term yields will provide the CAD with significant support in the coming months.
EUR/USD has had a very low correlation with US equities over the last three months. However, until events in Ukraine become clearer, we would presume the much greater exposure of European economies to the crisis. Currently, 1.1265 looks the bias for EUR/USD heading into tomorrow's FOMC - unless we see any substantial de-escalation of tension in Ukraine. Look for the euro to struggle over the next several days with events in Ukraine and the FOMC meeting driving direction.
Over the last week, events in Ukraine and the global equities decline have moved the focus away from inflation/tightening and toward a flight to safety leaving the GBP/USD more vulnerable. Domestically, calls for PM Johnson's resignation/removal are at an all-time high, but the BoE and risk story is far more relevant for the GBP right now. If Johnson resigns, his replacement is likely to be considered as a safe set of hands, and don't see any political risk premium built into the GBP.
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