Measures of the trade-weighted dollar index are around 2.5% off their highs of the year. The correction has nothing to do with any softening of Federal Reserve tightening expectations. The market firmly expects the Fed to hike 75bp on 2 November and prices a terminal rate as high as 4.90% next spring. There are three factors are behind this current dollar correction. The first is the reversal in UK fiscal policy. The second factor is global equity markets. And the third factor is energy. A quiet week for US data could see the dollar correction extend a little, however from a medium term perspective, expect the USD to continue to reign supreme.
The Bank of Canada's quarterly survey picked up a sharp fall in the business outlook while consumer inflation expectations reached 7.1% in one year and 5.2% in two years. Consumers and businesses see a 50% chance of a recession, while a Bloomberg survey put it at 45%. The Bank of Canada meets next week, and the swaps market is pricing in a little more than an 80% chance of a 75 bp hike. September housing starts and August portfolio flows will be reported today. Tomorrow sees September CPI. The headline pace is expected to slow for the third month, but the core rates are expected to be little changed. Follow through selling pushed the US dollar below 1.37 for the first time in a month. With equities firm and the intraday momentum indicator stretched, we look for the Canadian dollar trade on both sides of the 1.37 figure. Observe the USD/CAD trends.
EUR/USD went under parity in late August largely driven by the negative terms of trade shock of higher energy prices. That energy shock is temporarily going into reverse as European gas prices drop sharply on the warmer weather and European governments having largely achieved their gas storage targets. A quiet week for US data create a corrective window for EUR/USD the pair is likely to trade in the 0.980/1.0000 area.
As new UK Chancellor Jeremy Hunt carefully clawed back all the fiscal giveaways offered in late September, the question is how far should sterling now rally? Taking the UK sovereign credit default swap as a benchmark for levels of UK fiscal anxiety, one could mark out dates around mid-September (GBP/USD at 1.15) and the third week in August (1.18) as possible targets. While there may be some more fiscal positives to come were the Conservatives to look at a windfall tax on the energy companies, we suspect GBP will struggle to sustain gains over 1.15 this month.