Global Head of Macro Strategy
Summary: The US dollar is teetering on the brink, but has not yet been sent packing after the recent dovish shift from Powell. The market may be pressing its case on the latter as hard as it can for now. Elsewhere, the CAD rally looks remarkably aggressive ahead of tomorrow’s Bank of Canada meeting.
The risk rebound continued yesterday, though the extension higher was rather muted compared to Friday’s rally, and we wonder if the move has already largely played out as we have risen as much as 10% from the lows in the case of the S&P 500 index. Again, we point to the difficulty in sustaining a rally in sentiment merely on the Fed backing down, as renewed strong risk appetite and solid or better US data can only mean that the Fed will revert to its former hike path. And if the economy and financial conditions worsen, further shifts in the Fed’s stance are only in recognition of the bad news. I suspect this dynamic will drive the risk of a very choppy, back and forth market next quarter or more.
The rally in CAD has outpaced that of every other currency since yesterday after a stronger than expected Ivey PMI. The late CAD strength is in sympathy with the relief rally in risk appetite and oil prices. This looks more than anything like a short squeeze ahead of tomorrow’s Bank of Canada meeting. Have traders forgotten the jarring dovish shift in the BoC’s policy guidance at the December 5 meeting?
My suspicion is that we are seeing a CAD short squeeze that may reverse quickly in the coming days. Further muddying the outlook for the Canadian economy, on top of energy market and housing bubble unwind risks, the Justin Trudeau’s government has just introduced a novel new carbon tax that may weigh on growth. Trudeau is likely in the final months of his time as Canada’s prime minister, as he looks vulnerable to the country's version of national populism at the election later this year.
Chart: USDCAD
USDCAD potentially pivotal over the next couple of days after a brutal correction to the churning rally higher. The price action has taken us all the way back near the level of the last Bank of Canada meeting on December 5, in which it effectively abandoned its forward guidance anticipating further rate hikes. This latest bounce in risk sentiment and oil prices look far from sufficient to drive any shift back to a more hopeful outlook from Poloz and company tomorrow. Short dated USDCAD call options one way to trade a CAD retrenchment. Any remaining bulls here will want support to come in quickly after we have traded below the old 1.3385 highs.
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