Markets Betting On Larger Rate Hikes In Both Canada And The US
Market participants have continued to push their Federal Reserve rate expectations higher in the past week, and Fed funds futures are now almost fully pricing in a 5.0% peak rate for the May 2023 meeting. This marks a full 1% increase in rate bets in slightly over a month, largely driven by a firmly hawkish tone in Fed communication, strong labour data and – only last week – core inflation reaching a 40-year high.
If markets are right, and the Fed is embarking on a path to take rates to 5%, it’s hard to see the FX market going in a very different direction than the recent, dollar-dominated one, especially in the near term. The base case for this week is that the dollar will remain supported as the Fed’s determination to take real rates higher, paired with geopolitical and energy-related concerns, may keep risk sentiment on the back foot.
The combination of hawkish rhetoric by Bank of Canada Governor Macklem, despite words of caution from the IMF about risks of recession from the collective hikes, and the prospects of a more aggressive Fed has lifted expectations for a 75 bp hike next week. The swaps market now sees about an 78% chance of another three-quarters point move. Firmer equities can help the Canadian dollar pare last week's 1% decline. The Canadian dollar fell to new two-and-a-half-year lows in the middle of last week. Trading remained choppy in the second half of the week and the greenback finished slightly below 1.39. Look for significant volatility this week ahead of next week’s BoC rate announcement. Observe the USD/CAD trends.
This may be the decisive week for EU members to reach a final agreement on coordinated measures against the energy crisis. Over the weekend, a draft indicated that the proposal of a price corridor for wholesale gas transactions was set to be explored: this may be a bridge between the requests for capping gas prices and the concerns that a fully-fledged cap would lead to increased consumption. The content of the coordinated measures could have a more long-lasting impact on the euro than the ECB’s policy direction, at this stage. On the data side, the ZEW survey and final CPI numbers will be in focus this week. We still think that EUR/USD will test the 0.9540 September lows in the near term, and extend a drop below that level by year-end.
Expect another eventful week in UK markets. Prime Minister Liz scrapped the £18bn plan to avert a corporate tax hike. Expect a good deal of volatility around the announcement as the general consensus is that the fiscal U-turn will have a much larger scope than corporate taxes. Data will also be in focus this week, with CPI figures on Wednesday expected to show headline inflation at 10.0%, and the core rate at 6.4%. This should cement bets on a 100bp hike by the BoE in November.
We continue to see elevated volatility in the pound and mostly downside risks. The government will need to sound very convincing in their fiscal U-turn to bring cable sustainably back to 1.15-1.20. Sub-1.10 levels, also considering our call for a stronger dollar, remains our base case scenario in the coming months.
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