Bank of Canada may say pause, but the market hears finished

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Overview: Amid heavy losses in US stock futures, the US dollar tends to be firmer against G10 currencies. The notable exception is the Australian dollar, where higher-than-expected inflation raises the risk of a more aggressive central bank. The Aussie reached its best level since last August (~$0.7125). With a light US economic diary and Fed officials in the quiet period leading up to next week’s FOMC meeting, the focus in North America is mostly on the Bank of Canada meeting. An increase of a quarter point after last month’s 50 bps move is expected to end the cycle, but the central bank will want to keep its options open.

Asia-Pacific stocks advanced the most, with South Korea’s return driving the Kospi up 1.3%. Singapore markets also reopened and the Strait Times rose 1.8%. European equities are heavy and US futures point to a sharply lower open. Benchmark 10-year returns are typically 2-6 bps lower in Europe. The 10-year US Treasury yield is slightly lower near 3.43% after experiencing a three-day gain yesterday that brought the yield back above 3.50%. After API reported 3.3 million barrels on top of 7.6 million barrels last week, WTI is trading softer in March. If the losses continue, it would be the third consecutive decline and the longest streak in more than a month. Meanwhile, gasoline prices have continued to rise.

Asia Pacific

Accelerating Australian inflation led to higher interest rate expectations and boosted the Australian dollar sharply. The CPI increased by 1.9% in the fourth quarter, pushing the year-over-year rate from 7.3% to 7.8%. The average forecast in Bloomberg’s survey was a 1.6% quarter-on-quarter increase and a 7.6% year-over-year increase. Underlying measures were also stronger, and an additional inflationary picture was the acceleration in the new monthly measure from 7.3% to 8.4% in December. The Australian 2-year yield rose 10 basis points to almost 3.08%. In the futures market, participants flirted with a 15 basis point hike to bring the target rate back to quarter-point increments, but now see the greatest chance of a 25 basis point change in more than a month. Separately, New Zealand also reported a higher-than-expected Q4 CPI (7.2% vs. 7.1%), but instead of accelerating, it stagnated. The year-over-year rate was 7.2% in H2 after 7.3% in Q2. New Zealand’s two-year yield fell seven basis points and the New Zealand dollar is trading heavier. The swap market had already discounted at least a 50 bps increase in the RBNZ (February 22) and sees a 1 in 3 chance for a 75 bps move.

The Japanese Ministry of Finance will report weekly portfolio flows tomorrow (for the week ending January 20). Recall that in the previous one, where the BOJ was showing off, Japanese investors plunged into foreign bonds. More specifically, the MOF reported that Japanese investors bought JPY1.23 trillion (~$95 billion) of foreign bonds, the most since November 2021. For their part, foreign investors dumped nearly JPY3.9 trillion of Japanese bonds, one of the largest weekly liquidations although slightly less than after the December surprise (JPY 4.86 trillion, a record). What could prove to be the end of the G10 bond bear market and what appears to be a gradually improving current account balance could lead Japanese investors to continue returning to global bonds after last year’s sell-off.

The dollar is in a narrow range against the yen today, roughly JPY129.80-JPY130.60. That is within range of yesterday. Overnight implied volatility, which surged above 50% prior to last week’s BOJ meeting, is below 15% and back within the worn-out range. We expect the dollar to challenge session highs in North America again, but likely to stall before yesterday’s short push above JPY 131.00. rising above $0.7100 today, the Australian dollar has reached the (50%) retrace of its decline from its February 2021 high just above $0.8000. The next retracement target (61.8%) is near $0.7300. Recall that last week’s low was near $0.6870. The combination of China’s reopening narrative and the reassessment of the RBA’s trajectory has sent the Aussie up nearly 4% this year to lead the G10 currencies. The upper Bollinger Band is near $0.7100 today. It has retreated to around $0.7080 in European morning and initial support can be found around $0.7060. With the mainland closed, the offshore yuan is trading calmly. The dollar remains between CNH6.7650 and CNH6.7950. Finally, as widely expected, Thailand’s central bank has made a 25 basis point increase, bringing the target rate to 1.50%.

Europe

Prime Minister Rutte is throwing a spanner in the works of a common European response to US green subsidies. EU President von der Leyen, France and Germany seemed to be in favor of a joint response. Although Rutte is in favor of a reaction, he does not think that more debt should be issued. He noted that funds are still available from the €800 billion NextGeneration recovery fund, which should allocate just over a third of each country’s spending on the transition to more sustainable energy. This, of course, is the kind of response one might expect from the more fiscally conservative governments. The same goes for his opposition to any relaxation, at least temporarily, of state aid rules, as some have suggested, including von der Leyen. It is also part of fighting for a position ahead of the EU summit on February 9-10 that will address the issue. The risk of more national strategies is that this could lead to a further fragmentation of the eurozone. Remember, last year’s German decision to commit 200 billion euros to protect businesses and households against a rise in energy bills drew the wrath of more tax-bound countries. The Financial Times reported on the matter, two days after what turned out to be the euro’s bottom (~$0.9535 on Sept. 28), saying Germany’s plan sparked “hostility” within the EU.

While economists have become more bullish on the Eurozone, and Germany in particular, the IFO survey was less than impressive. The current rating for January fell from 94.4 to 94.1. The market had been looking for some improvement. The expectations component increased from 83.2 to 86.4. It is the fourth win in a row and the most optimistic since last May. The overall business climate measure rose from 88.6 to 90.2, but slightly missed expectations. Finally, the dispute over sending tanks to Ukraine has been resolved and Germany was widely criticized, eventually appearing to get what it was after with the US also sending its tanks. In addition, Germany reportedly lobbied Switzerland to lift its ban on re-exporting Swiss-made weapons to Ukraine.

The euro penetrated as low as $1.09 in Asia but appeared to have sparked some profit-taking that took it to near $1.0860 on European morning, the lows of the session. With momentum indicators becoming oversold during the session, yesterday’s low near $1.0840 may hold. Recall that the $1.0940 area corresponds to the (50%) retrace of the Euro’s decline from January 6, 2021, high near $1.2350. The risk averse mood, reflected in the heavy losses on US stock futures and what may be the first consecutive loss of the Stoxx 600 since the middle of last month, could undermine the euro’s strength. That said, the pullbacks in recent months have generally been superficial and almost everyone seems optimistic. Sterling posted a four-day low near $1.2265 yesterday before falling back around $1.2335. It is consolidating within yesterday’s range today, but has spent little time higher than yesterday’s close. Short-term risk may extend to $1.2215-20, but the push to European morning lows (~$1.2285) is stretching intraday momentum indicators.

America

The Bank of Canada meeting is the main event today. A quarter-point increase is widely expected by economists, but is not fully discounted in the swap market. Recall that at last month’s meeting, the market was split between 25 bps and 50 bps. We acknowledged it was a close call, but preferred the half point move that delivered. The challenge of today’s meeting is how to deliver the quarter-point increase and signal a pause without fueling market expectations that it is done with the overnight rate at 4.50%. In addition, the swap market will see the policy rate close to 4.00% by the end of the year. The Bank of Canada forecasts that the economy will grow by just under 1% (annualized) this year from about 6.8% at the end of last year to 4.1% at the end of 2023. The IMF expects the Canadian economy to grow here in grow by 1.5% through 2023, with the CPI moderated to 4.2%. Meanwhile, the Canadian dollar was the best performing currency in H1 22, losing only 1.8% against the US dollar. However, in H2 22 it performed worst, with a loss of 5%. Here it is up about 1.4% in January, the worst of the dollar bloc (Australian dollar is up about 3.3%, while New Zealand dollar is up 2.4%). Of the G10, only the yen, Swiss franc and Norwegian krone have underperformed the Canadian dollar.

The US has a light economic schedule today, but it picks up again tomorrow with the first estimate of GDP in the fourth quarter. The Atlanta Fed’s GDPNow points to 3.5%, while the median forecast in Bloomberg’s survey is down to 2.6%. Last month’s summary of the Fed’s economic projections shows that the long-term trend, which is considered the non-inflationary growth rate, is around 1.8%. Tomorrow December’s trade balance and stocks (wholesale and retail) are also available. Weekly jobless claims may also draw more attention than usual a week ahead of the nonfarm payroll report, after the unexpected drop to below 200,000 was reported for the week ending Jan. 14. There appears to be an unusually large drop in applications from New York. Orders for durable goods and sales of new homes will also follow tomorrow.

Ahead of the Bank of Canada meeting, the US dollar remains limited to Monday’s range against the Canadian dollar (~CAD1.3340-CAD1.3420). Weakness in US stock futures may have helped lift the greenback to session highs in Europe and is stretching momentum indicators. That said, a move above CAD1.3420 could mean a quick move to CAD1.3450 -70. After peaking near MXN 19.11 on January 19, the US dollar has gradually retreated, reaching around MXN 18.7670 today. This is about the (61.8%) retracement from last week’s peak. The risky mood may indicate that consolidation is likely in the near term. The potential may extend to yesterday’s high, slightly above MXN 18.88.

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