The dollar broke to a new cyclical high yesterday. Dollar strength is clearly being driven by a hawkish Fed. The big question for markets now is how quickly the Fed tightens? Currently, the futures markets price a 31bp Fed hike at the March 16th FOMC meeting. We think it unlikely that the Fed would start the cycle with 50bp, but that may not prevent market pricing from briefly heading in that direction over the coming months.
Today's 4Q Employment Cost Index (ECI) release could have a big say in that pricing. The 1.3% QoQ ECI saw in 3Q was huge and another 1.2% QoQ is expected in 4Q. Any higher and the 50bp March hike proposition becomes a little more likely and the dollar will push ahead further. For today, the ECI will determine whether the DXY pushes on above 97.00.
The Bank of Canada met the consensus estimate of keeping interest rates on hold earlier this week, but the result disappointed market expectations. With economic slack fully absorbed, policymakers indicated a substantial shift in monetary policy in March, with a series of rate hikes possibly to follow. By July, markets expect four rate hikes, with two more hikes in the second half of the year. The CAD has weakened since the Bank of Canada's decision, and it has weakened much more since the Fed's announcement. This morning, the USD/CAD is trading at 1.2782. We see limited downside for the CAD versus the USD and scope for decent gains over the rest of the year on the basis of monetary policy prospects. For today there isn’t much happening domestically leaving the loonie to trade on broader market themes.
EUR/USD has broken clear of support at 1.1180 and looks headed towards 1.10. Most suggest that next week's ECB meeting will offer little interest rate support to the Euro. For today the focus will be on Euro area 4Q GDP releases. Weak growth only serves as a reminder that the Eurozone is still running a negative output gap and that the ECB will be in no hurry to hike rates.
Current pricing for the BoE's UK base rate is now at a staggering 1.35% for the December BoE meeting. In the past, in a deflationary environment with weak global demand, a former BoE might have issued a verbal rate protest against such pricing - in order to weaken GBP. However, we suspect that the BoE is currently welcoming GBP strength in its fight against higher energy prices. A 25bp rate hike next week and no protest against market pricing of rate hikes should see the GBP continue to remain well supported.
Check GBP/USD Conversion Chart
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