Head of FX Strategy
Summary: Market nerves further frayed yesterday as yields continue to rise and the White House frets an “extraordinarily elevated” US March CPI release today. Also, a sharply steepening yield curve in the immediate wake of sharp flattening demands our attention. Tonight, we watch for a rate hike and guidance from the RBNZ, tomorrow brings likely the large Bank of Canada hike in over 20 years, and Thursday features the between-a-rock-and-a-hard place ECB.
FX Trading focus: US CPI and yield reactions, Bank of Canada, GBPUSD at support, ECB Thursday.
The risk sentiment slide yesterday gathered further momentum as the Biden White House was out fretting an “extraordinarily elevated” March CPI release today. Whether that is simply to prep the general public for the first 8-handle on the headline year-on-year CPI in over 40 years or because it has had a sneak peek at the data and it is even worse than the consensus expectations for an 8.4% reading (and 1.2% month-on-month, with core expected at +0.5% MoM and +6.6% YoY) is impossible to say. A 9% CPI rate could encourage the market to look for a move straight to 1.00% at the May FOMC meeting, something the market has not yet been willing to price, preferring instead to predict multiple 50-basis point moves.
More interesting than the data itself will be to track the market reaction in longer maturity treasuries after we have seen a strong pivot in the direction of steepening of the yield curve in recent days. As I discussed in this morning’s Saxo Market Call podcast, there could be a couple of ways to interpret this, the most alarming being that the market has become less concerned that projections of Fed tightening are getting too aggressive and therefore eventually risking an incoming recession. Instead, a continued steepening of the yield curve here could suggest that the market thinks that the Fed is not in any way in control of the narrative or inflation yet, with the risk that an inflationary mind-set has taken hold that could suddenly bring forward demand (make large purchases now and generally hoard what can be hoarded rather than waiting for price rises later) and lead to a scramble for hard assets and spiking monetary velocity. This would trigger the risk of a titanic inflationary bust in the worst instance. Stay tuned.
Somewhat related to that last note, commodity price behavior is another key here, as oil has responded strongly from yesterday’s dip and if you look out the curve on oil prices (forward futures prices next year for example), we have hardly corrected lower. The interpretation is along the lines of: short-term, the demand reduction from Chinese lockdowns in particular and the supply increases from the huge reserves releases recently announced will keep prices reasonably orderly for now, but the longer term price of oil has been significantly and durable adjusted higher, eroding the argument for a powerful mean reversion in prices in the longer term – especially as reserves releases today could mean reserves builds tomorrow, particularly in an environment when central banks will question the point of holding negative-real-yielding FX reserves far beyond any basic need for trade transactions, preferring rather to hold actual oil and perhaps gold as well. In short, I am as interested as much in the impact of commodity prices on this environment as I am in central bank moves, which are merely chasing the situation rather than controlling it.
Chart: USDCAD
USDCAD has bounced back to just about the half-way point of its slide from the early March highs inspired by the risk-off meltdown in the wake of Russia’s invasion of Ukraine. One the one hand, CAD under pressure from weaker risk sentiment of late and the correction in oil, although as we point out above, the market has repriced longer term oil prices significantly higher. And Canada’s trade bounce has pulled out of a long period of large deficits to begin posting solid trade surpluses. The Bank of Canada tomorrow is seen hiking 50 basis points for the first time since 2000. If the focus in coming days is on inflation risks and crude oil rebounds strongly without a strong melt-down in risk sentiment, USDCAD could post a key reversal lower if the BoC encourages the market’s forward pricing of its hiking intentions (currently looking for a BoC policy rate near 2.2% by year end – about in-line with Fed expectations.)
Sterling is struggling near 1.3000 against the US dollar. Yes, BoE expectations have marched higher this week despite weak GDP data yesterday, but as the February earnings data showed earnings rising at +5.4% clip year-on-year w/ bonus on top of last year’s solid +4.3% YoY for Feb (in other words, not due to some basing effect). The UK economy is severely supply constrained on the same energy spike that will limit real growth and due to labour shortages made far worse by the post Brexit environment. Given the UK’s commodity import dependence and already yawning traded deficits, the country will have to attract heroic amounts of capital to keep sterling imbalances from weighing. Surprised it has held in so well at this point and perhaps the negative focus on the euro is the reason.
The ECB is up Thursday after Friday saw a report suggesting that the ECB is preparing some kind of facility in the event “weaker” EU economies suffer a blowout spike in yields. This double underlines the forward risk that has been bandied about, also in this column, that the ECB may have to continue QE at least for parts of the “fragmented” EU sovereign market, even if it is tightening via raising rates. This doesn’t have to be euro negative if the ECB is willing to send credible signals on stopping balance sheet expansion and the intent to hike rates sooner.
Table: FX Board of G10 and CNH trend evolution and strength.
The commodity currencies have eased back on the latest risk off and commodity consolidation combo, but could be ready for a renewed charge. Elsewhere, watching for whether the USD could be toppish for the same reason, when Japan’s Ministry of Finance will scream “uncle” and for any NZD bump from the RBNZ to be faded.
Table: FX Board Trend Scoreboard for individual pairs.
Watching gold and silver for potential signal on commodities and therefore commodity FX as well. Also note that USDCAD is pivotal as noted above ahead of the Bank of Canada meeting. otherwise, the loudest thing on the FX board is the cold blue ATR reading for USDCNH – ahem.
Upcoming Economic Calendar Highlights (all times GMT)
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
