For most of 2022, the FX theme was the divergence between the hawkish Fed and the more dovish major G10 central banks. Evidence that the US economy and inflation are starting to slow down as well as hawkish surprises from the ECB and the BoJ in recent months have all put an end to the USD-divergence trade. The big question at the start of 2023 is whether a policy convergence between the Fed and the rest of G10 FX would pave the way for trend-reversal lower for the USD across the board. We remain of the view that expectations of a dovish pivot by the Fed are somewhat premature given the bank’s focus on the persistently elevated US inflation and the relative resilience of the US economy in general. We expect this to be confirmed by today’s Fed minutes and the employment component of the ISM manufacturing for December. We expect that any positive data surprises from today’s data as well as evidence that the Fed remains firmly committed to delivering on its inflation mandate could keep the USD supported across the board.
Quite a wild ride yesterday. The US dollar rose slightly more than 0.7% against the Canadian dollar yesterday, its largest gain in a couple of weeks, and approached 1.3685. Rebounding US equities and the risk-on sentiment have offset the continued pullback in oil prices. February WTI is off 2% after yesterday's 4.1% drop. It has approached $75 a barrel, the lowest in nearly two weeks. The greenback has returned to the 1.3550 area this morning. Employment data out of Canada and the U.S. will be key on Friday but there remains significant concerns around the Canadian economy as BoC may overtighten. Observe the USD/CAD trends.
Europe has had one of its warmest starts to the year on record so far in 2023 and this has added to the downward pressure on the Eurozone energy prices, helping ease the worst of stagflation fears in the market. The falling energy prices have helped ease inflation pressures with the German CPI data coming in below expectations yesterday and further fuelling expectations of a similar undershoot from the Eurozone HICP data due on Friday. As a result, investors have started reassessing their expectations of further aggressive tightening by the ECB. On the day, focus will be on the Eurozone final services and composite PMIs for December.
The pound has recovered from yesterday's drop that took it to almost $1.19, which it has not traded below since November 23. It has bounced to yesterday's high ($1.2085) where it has stalled. Strikes and the persistent cost-of-living crisis make for an painful backdrop for the GBP to start the year. Transport strikes are slowing the return to work after the holidays and are likely to increase pressure on the UK government finances.
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