We recently argued that the dollar rally would run out of steam, as the hawkish repricing of Federal Reserve rate hikes has likely peaked, and that external factors would be a more likely cause of further USD appreciation. This has indeed been the case since market action resumed after Monday’s holiday, as a return of geopolitical risk weighed on global risk assets and buoyed the safe-haven dollar. The focus is now on Russia’s next moves on the Ukraine front ahead of a potentially turbulent anniversary of the invasion, at a time when China – a key ally for Russia – has seen a rapid deterioration in its relationship with the US.
Geopolitics aside, markets will watch with great interest the content of the FOMC minutes today. With markets pricing in close to a 5.50% peak rate, we would need to see evidence that multiple members voiced the desire to hike by 50bp at the start of February. That would back the cause for a 50bp move in March, and likely lift the dollar.
Weaker than expected Canadian retail sales coupled with the more modest increase in price pressures may have lent support to the Bank of Canada's pause that was being questioned after the recent unexpectedly strong employment report. Headline inflation rose by 0.5% allowing the year-over-year rate to fall below 6% for the first time since last February. The US dollar is extending its gains against the Canadian dollar. It has reached 1.3560, its best level since January 6. Look for the CAD to weaken further on external factors including geopolitical risk and today’s FOMC minutes. The USD/CAD is likely to target 1.36 today.
Yesterday’s PMIs clearly pointed to an improving picture in the eurozone. However, the resurgence of geopolitical risk in Russia/Ukraine is inevitably curbing appetite in the common currency. We think that support around 1.0640-1.0660 is enough of an encouraging sign for EUR/USD given the strength of the dollar. A hawkish surprise in the FOMC minutes and/or more geopolitical risk being priced in would likely put the 1.0600 support at risk. But unless those two risks materialize, a good Ifo reading in Germany today and stabilization in sentiment may actually start to favor a move back to 1.0700-1.0750 before the weekend.
The pound has continued to display very good resilience despite a re-strengthening in the dollar, this time thanks to very strong PMI readings yesterday. A big (and unexpected) jump from 48.5 into expansionary territory (53.0) is favoring a re-rating of growth expectations in the UK, which is ultimately translating into rising bets on Bank of England tightening – the biggest driver of GBP performance of late. We are not convinced the BoE will ultimately deliver more than one hike and we are struggling to see a sustainable outperformance of the GBP in the coming months.