The dollar started the week on the back foot yesterday, as the FX market appeared to trade largely on a risk-on narrative. Contributing to the softer dollar environment has been the repricing lower in the Fed’s rate expectations, with the prospect of a 100bp rate hike in July now almost fully priced out. While most doubt that the market will find any reason to realistically reconsider a 100bp move before next week’s FOMC meeting, analysts continue to see a 75bp move as enough to put a floor under the dollar in the near term. We expect some consolidation in the dollar around current levels this week. Another round of risk-on trading in FX is surely possible and could trigger another small dollar correction, but the overall environment seems unlikely to warrant a more sustained dollar contraction.
The US dollar is regaining ground against the Canadian dollar after falling from roughly 1.3225 to 1.2900 yesterday. This decline has lasted three days. The gains in the Canadian currency were immediately pared as a result of the shift in risk appetite as US equities gave up their initial gains, and the US dollar virtually recovered to 1.30. The CAD is unable to gain much ground below 1.29, despite increased risk appetite, higher commodities, and a 100bps rate hike by the BoC. Concerns about domestic growth are probably responsible for part of the CAD's poor performance. It is now trading within a 25–30 tick range on each side of 1.2960 so far today. The best directional hint may be provided by stocks. In the upcoming weeks, watch for the CAD to trade on both sides of 1.30.
EUR/USD touched 1.0200 for the first time in nearly two weeks yesterday and currently is trading slightly below this level, but we see the resistance partly as a testament to how the challenging environment in the eurozone is keeping any bullish sentiment on EUR capped - another drop to parity is possible over the coming days. The gas supply story also remains highly in focus and bears the risk of triggering a significantly bigger drop in the euro. The European Commission estimated yesterday that a cut-off of Russia’s gas supply would trim 1.5% off the EU’s GDP. It’s likely that we’ll hear more developments on that over the coming days. The EUR/USD seems to be trading mostly in line with the dollar but current dynamics suggest a downward-skewed balance of risks.
The latest UK jobs data is unlikely to change too many minds within the Bank of England's policy committee. Those that have been pushing for 50bp rate hikes will remain concerned about worker shortages and the impact on wage growth, while the doves will focus on some fresh signs that the jobs market is no longer tightening. Still, given that markets are fully pricing in a 50bp hike and that the MPC is concerned about recent sterling pressure, we narrowly think the BoE will implement a 50bp hike at its August meeting. If markets see more reasons to fully price in a 50bp rate hike in August, we could see some benefit for the pound, but GBP/USD is set to remain mostly driven by external factors and dollar dynamics.