Volatility remains the name of the game and the dollar is now seeing one of its deepest corrections of the year. If we were to say what drove dollar weakness yesterday, we would highlight: i) quite a sharp turn lower in USD/CNY and ii) the smaller than expected Bank of Canada (BoC) rate hike by 50bp. That brings us to today where we will receive third-quarter US GDP data. There are downside risks to the consensus figure of 2.4% QoQ given softer residential investment and consumption. Such an outcome could feed the corrective forces currently at work for the dollar. However, high US inflation data tomorrow and what should be a hawkish Fed next week should contain the depth and length of this dollar correction.
With a 50 bp increase rather than a 75 bp one, the Bank of Canada surprised the market. The US dollar increased sharply, from about 1.3580 to 1.3650. It lost all of its gains in one hour and fell to about 1.3540. US stocks fell in the afternoon while the USD currency strengthened again above 1.3580. Bank of Canada Governor Macklem stated that the growth is starting to be affected by the previous hikes, which have increased by 225 bp since the end of H1. The Bank of Canada revised its expectations, reducing Q3 growth from 2.0% to 1.5% and projecting Q4 growth of 0.5%. The growth prediction for 2023 was cut in half, to 0.9%. Macklem was unambiguous at the same time: there was no convincing evidence that the underlying price pressures were subsiding. However, the inflation predictions for this year and the next year were both lowered, from 7.2% to 6.9% and 4.1% to 4.6%, respectively. With CPI exceeding the target, it would appear that the Bank of Canada will halt tightening monetary policy. The US dollar is currently trading with a firmer tilt inside of yesterday's range. The CAD1.3650 high from yesterday might be put to the test. Observe the USD/CAD trends.
The European Central Bank is expected to hike rates by 75bp today, which will bring the deposit rate to 1.50%. Money markets price the deposit rate being taken to 2.75% in a year's time. With Eurozone CPI running at 10% it is too early to expect the ECB to push back against such pricing. The ECB’s the terminal rate will depend on i) excess liquidity and ii) Quantitative tightening (QT). What does this all mean for the euro? The ECB has surprised hawkishly all year - but EUR/USD has generally ended ECB policy days weaker. We continue to expect a weaker euro in the medium term.
GBP continues to enjoy a resurgence, but we would argue that further gains will be harder to come by. increasingly the markets will be left to focus on the UK fiscal/monetary policy mix. The delay in the release of the government's fiscal plan to November 17th serves as a reminder that there is a lot of ambiguity around what’s to come. Does the delay signify greater cost-cutting at work? Where the ground looks slightly firmer is on the Bank of England (BoE) side. A recent speech by the BoE's Ben Broadbent makes the case that the BoE does not need to respond as aggressively as the markets have priced to government spending plans. The softer dollar environment means that the GBP/USD correction could extend to the 1.1750 area - but we doubt these gains last.
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