The USD continues its reign over FX markets in a classic ‘USD-smile’ fashion, supported by market expectations that the Fed will deliver the most rate hikes this year in G10. In turn, this reflects investors’ belief that the US growth outlook remains superior to that in Europe and Asia, where geopolitics and the pandemic continue to weigh. The aggressive Fed tightening plans and safe haven appeal of the USD continue to support the greenback. All that being said, with the US rates markets already pricing in policy rates to exceed 3% in 2023, it seems that many Fed-related positives are already in the price of the USD. Economists and rate strategists further think that the US inflation is close to peaking and should come off the boil in coming months. We also note that the US stocks are starting to look very expensive relative to both the European and Asian stock markets as well as the US fixed income market. The FX market focus this week will remain on the FOMC speakers with the appearance by Fed Chair Jerome Powell on Thursday likely to be the highlight. Given that the US rates markets are already pricing in c.50bp of hikes ahead of the 4 May policy meeting, however, we doubt that Fedspeak alone can give the USD a lasting boost. In our view, it will take further escalation of geopolitical risks in Europe and/or further deterioration of the pandemic situation in China to push the USD higher across the board.
After the overtly hawkish message from the BoC on Wednesday, it was a little surprising to see USD/CAD close the London session back above 1.2600 after hitting a low of 1.25215. CAD-specific tailwinds remain solid and should pull the USD/CAD back from 1.26+ levels towards a test of 1.24 in the coming days/ weeks. Canadian CPI tomorrow should reinforce expectations for another large BoC hike at its June policy meeting with economists expecting a 6%+ y/y inflation reading. Markets are pricing in a 90-95% chance of a 50bps increase, but this does not seem to be reflected in CAD price action which remains weighed by broad dollar strength.
Last week’s European Central Bank meeting clearly fell short of the market’s hawkish expectations and forced a re-pricing of tightening bets. A key takeaway for FX is that the Fed-ECB gap, which is a major determinant of EUR/USD is set to remain wide for longer. We’ll hear from President Christine Lagarde this week, but we doubt she will make any significant U-turn on the policy rhetoric. On the data side, PMIs will be in focus. Along with the underlying unsupportive policy differential, EUR/USD will face other downside risks this week, as the second round of the French elections (24 April) draws nearer. Latest polls seem to suggest a relatively safe lead for President Emmanuel Macron over rival Marine Le Pen, but we suspect appetite for the EUR will remain low into this weekend’s vote. A combination of these factors continues to argue against a recovery in the euro, in our view, and EUR/USD may test 1.0700 in the coming days.
The only two releases to keep an eye on in the UK calendar this week are tomorrow’s retail sales and PMIs, as well as speeches by Bank of England Governor Andrew Bailey and Catherine Mann on Thursday. GBP/USD is currently trading around 1.3000: breaks below this level have proven to be very short-lived in previous instances (March-April), but we think that a supported dollar and the lack of major drivers for this week could support a more decisive depreciation in GBP/USD.
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