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USD directionless; BoC to tread carefully tomorrow

USD - US Dollar

A slow start to the week in terms of data releases saw markets turning more optimistic on the Omicron variant story and – while still waiting for more details on the vaccine efficacy FX has recovered some ground.

Today, we may get a bit of the same as yesterday: there are no major data releases in the US and no Fed speakers given the pre-FOMC blackout period. The dollar may simply remain rangebound with sentiment on the Omicron variant still set to drive most market moves. Investors will also keep an eye on developments on the US-Russia diplomatic tensions, as Biden is reportedly considering sanctions on Russian banks if Russia invades Ukraine.

CAD - Canadian Dollar

CAD has recovered some of its recent losses at the start of this week, as a rebound in risk appetite and oil prices generated some much-needed reprieve. With market sentiment on the risks associated with the Omicron variant changing quite rapidly, it is hard to predict whether the loonie will still have a good tailwind into tomorrow's BoC policy announcement. Most expect the BoC will take a more cautious approach given the lingering uncertainty around the risks and economic impact of the new variant. At the same time, the bar for a hawkish surprise seems quite high too; the market is back to pricing five rate hikes next year as strong jobs data on Friday helped revert the current downtrend.

All in all, most think the BoC won't surprise markets and that CAD will be only marginally impacted by the policy meeting tomorrow, leaving the currency almost solely driven by external factors for now. Barring a major setback to the global economy due to the Omicron variant, expect USD/CAD to consistently trade below 1.25 in 2022.

EUR - Euro

It appears that the euro’s role as a funding currency is curbing the EUR/USD upside in the current market environment, as investors are moving toward risk-on bets. With the eurozone growth outlook already partly compromised by restrictions in Germany and other eurozone countries, and the European Central Bank sticking to a broadly dovish tone, the euro may be facing more pressure regardless of Omicron-related sentiment. The EUR/USD could re-test 1.1200 this week.

GBP - British Pound

We’ve seen a divergence in how central bank officials have addressed the Omicron risk in the UK and US. While the Federal Reserve sent some hawkish signals and still sounded quite focused on spiking inflation, the Bank of England saw even some of its more hawkish voices take a more cautious tone. The market is currently pricing in 7 out of 15bp of tightening at the 16 December meeting. This divergence in policy expectations may keep a lid on the GBP’s upside in the run-up to the BoE meeting despite the upbeat risk sentiment.

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