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Loonie continues to hold its ground, ahead of inflation data

USD - US Dollar

The USD is trading for the week following last week’s reversal in the DXY index. We continue to think that the sudden burst of USD bearishness last week was misplaced, given the policy outlook. Rising yields and wider interest rate spreads will constitute a key source of support for the USD in the coming months. Fed policymakers appear to be tilting more hawkish in response to rising and more persistent inflationary pressures. A return to neutral policy may come sooner than markets are currently pricing and expecting. The data calendar is relatively light in the US today.

CAD - Canadian Dollar

The CAD was able to hold its ground against the resurgent USD so far this week. Two factors can explain that resilience: (1) the fact that the CAD has traditionally enjoyed a strong positive correlation with the USD and (2) the very strong BoC Q122 Business Outlook Survey released on Monday. Ahead of the CPI release today, market consensus is for headline inflation to accelerate further, moving even closer to 5% YoY, while the core gauges should also point to growing price pressures. And, while the retail sales data due on Friday can show some temporary weakness, in the wake of the latest Covid wave, we think that the BoC will pay closer attention to the structural issues of heftier constraints coming from capacity utilization and labor supply. In all, absent any significant downside surprises from today’s CPI data and Friday’s retail sales, the front loading of rate hikes should continue to support the CAD ahead of next week’s BoC meeting.

EUR - Euro

After falling below the 1.14 barrier earlier this week due to a rise in US yields, the EUR is again trading in the mid 1.13s. Investor mood in Germany fell to a nine-month low in January, according to the ZEW investor survey earlier this week. Investor expectations increased and surpassed experts' predictions, climbing to 51.7 from 29.9, as the current virus wave is not likely to have a long-term impact on the German and Eurozone economies. However, since supply chain concerns continue to hamper industrial capacity, the expectations index is still considerably below its mid-2021 highs. Due to low-interest rates and slower medium-term economic development, the EUR will stay at a disadvantaged against the USD, and most expect the beginning of the Fed’s tightening cycle to take the EUR to a test of 1.10 in the months ahead.

GBP - British Pound

The GBP has lost strength as global risk sentiment has weakened in response to continued tightening of US and global financial conditions. FX investors also seemed to ignore yesterday's batch of largely stable labor market data. The significant reduction in weekly wages suggested that real incomes are no longer able to keep up with increasing inflation. If this trend continues, domestic demand in the United Kingdom may be harmed. Today, attention will be on the December CPI report, with consensus predictions for continued annual headline increase and modest stabilization in core inflation. Even if the data exceeds market expectations, the GBP may continue to struggle, particularly if risk sentiment remains low. With four BoE rate rises already priced in for this year, beginning in February, and domestic real earnings already under pressure, a bigger inflation print today might fuel stagflation fears, adding to the GBP's headwinds.

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