The trade-weighted dollar remains close to its highs, likely being shielded from the equity rally thanks to market expectations of a 75bp Federal Reserve rate hike in November, and a terminal rate priced at 4.90-4.95%. As long as the Fed retains its hawkish stance (we suspect well into 2023), dollar corrections should continue to prove short-lived. Today’s US calendar includes housing starts and building permits data, which will provide hints of how much strain is being put on the housing market from sharply rising mortgage rates. Given the elevated weighting of shelter in the US inflation basket, a (controlled) downturn in house prices would likely mean a faster slowdown in inflation in 2023, and this is good news for the Fed. It’s probably too early anyway to see a material impact on Fed rate expectations from the housing data. We expect a consolidation in the dollar around current levels, and retain a bullish view on the greenback into year-end.
The Bank of Canada will announce policy next week, and most expect a moderation in the tightening pace to 50bp as the economy starts to show signs of slowing. Today, September CPI numbers will be published, and the consensus is centred around a slowdown in headline inflation from 7.0% to 6.7%. With markets currently pricing in 60bp ahead of next week’s meeting, any upside or downside surprise can definitely direct rate expectations towards 50bp or 75bp and generate CAD volatility in both directions. The balance of risks appears slightly skewed to the upside for CAD, but there is still room for USD/CAD appreciation (1.38-1.40) into year-end.
EUR/USD has been stabilising in the 0.98-0.99 area after the rally from 0.9700. Dollar strength remains the main hindrance to recovery in the pair, but the domestic picture is still far from appealing to investors. Despite a smaller-than-expected slump in the ZEW expectations index, the current situation survey plunged dramatically to -72.2 in October. These are levels last seen only in 2020 and 2009. The easing in gas prices is likely preventing a return to the 0.9540 lows, but think the next round of dollar appreciation will heavily test that support.
In a matter of days, the UK government has shifted from a large and unfunded expansionary fiscal policy to measures clearly in the direction of fiscal constraint. Looking at what the government has already changed from the "mini" Budget, the implications for markets are very significant. The U-turn in energy bills cap can add 2-3pp to inflation next year and should increase the size/length of the recession. The Bank of England will need to take this into account and will hike by 75bp rather than the 100bp expected by investors at the November meeting. With inflation hitting double-digits today (10.1%), with the core rate at 6.5%, makes any dovish surprise a harder sell. Most struggle to see a return to 1.15+ levels in GBP/USD, as a combination of political instability, risks of a deeper recession and smaller rate hikes by the BoE more than offset the benefits of quieter debt-related concerns
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