News & analysis


Yesterday’s double whammy of US CPI and a Fed decision didn’t disappoint in terms of the volatility it produced. While we believed going into yesterday’s session that the bar for core inflation to trigger a sizable dollar sell-off was high given the current market climate, printing at just 0.163% month-on-month, it was easily cleared. Behind the sudden stop in core inflation was core services ex shelter, a measure the Fed has been paying particular attention to determine domestically produced inflation. The so-called supercore measure fell from 0.42% MoM to –0.04%, leaving the 3-month annualised rate to drop more than 2 percentage points to 4.19%. The data compounded the signal from April’s report to debunk fears that arose in Q1 over inflation persistence and led markets to once again turn more dovish on the Fed. Pricing of a September cut rose 25 percentage points to 83% and the probability of two rate cuts this year jumped to 96%. This left Treasury yields on track to record their worst session since early May, when April’s CPI report also induced a rally in bonds, which naturally weighed on the dollar. The DXY index fell close to a percent intraday, with losses largest against Scandi and Antipodean currencies. However, the post-CPI moves proved short-lived, as members of the FOMC weren’t as confident as markets in interpreting just one inflation data point. As Chair Powell confirmed, members of the Committee had the opportunity to adjust their forecasts to reflect the latest data, but few did. This left the dot plot of rate projections to point towards a base case of just one rate cut this year, with the two removed spread evenly over the course of the next two years, where the median dot projected four rate cuts apiece. With the distribution also skewing in a hawkish direction as the mean dot sat above the median from next year onwards, the message from the Fed was one of hawkish caution. This took some of the steam out of the post-CPI relief rally and underscores our view that it remains too early to turn on the greenback.

With the Fed in the rearview mirror, the focus returns to local stories today. This is having the most prominent effect in emerging markets. Constructive coalition headlines out of South Africa have continued to support a rally in the rand. The contrast in investor sentiment couldn’t be starker in Latin America, however. Fears of constitutional reforms undermining democratic values have extended the Mexican peso’s post-election sell-off to 10% now, with the once market-darling struggling to even find support when the dollar sold-off alongside Treasury yields following May’s inflation report. Meanwhile, both the Brazilian real and the Colombian peso shed a percent yesterday on fears that both respective governments will fail to achieve their fiscal targets. In the case of the former, concerns have now arisen that this will induce significant political pressure on the central bank, where policymakers last month were already divided on their decision to cut based upon political as opposed to economic factors. While today the focus is likely to remain on the EM space as a result, overnight the focus will shift to Japan, where the BoJ is reportedly set to taper its QE programme further. The balancing act is whether the BoJ can tread the narrow path between announcing too significant a reduction in JGB-purchases that this triggers a sharp move in back-end yields versus too little that will trigger a sharp sell-off in the yen. Given the risk, the overnight session is likely to remain volatile.


The single currency rallied over a percent on the back of softer US inflation data yesterday, highlighting that French politics isn’t in the driving seat for currency markets. That said, with the Fed dialling back some of the dovish enthusiasm in markets, EURUSD saw its wings get clipped, leaving it to fall back to the low 1.08s, levels it was trading before the French snap election was announced.  That said, with little eurozone and US data set for release for the remainder of this week, attention is likely to flip back to the political circuit, where we are still awaiting election manifestos from the main parties.


Wednesday saw GBPUSD climb around half a percent and GBPEUR easing by two tenths, as markets had to contend with both US CPI and a Fed meeting, whilst also continuing to digest election developments out of France. All told, it was a busy day for sterling traders, with today unlikely to bring much relief. A weaker than expected RICS report released this morning has seen some downside pressure on sterling continue through early trading. Today though, it is UK election developments that are likely to be in focus for markets. Admittedly, we have been sceptical so far this campaign regarding the impact the election will have on the pound. This has largely been borne out too, with sterling little moved by election developments. But, with a 20% lead in the polls and victory looking close to guaranteed, today’s Labour’s election manifesto launch will be the first chance to get a steer on the UK’s likely fiscal outlook for the next five years. If as we expect, the manifesto is a mix of moderate policies, this should once again leave the pound broadly unmoved, with the potential for modest upside if accompanied by some sensible reforms. That said, where there are risks, these are skewed to the downside in our view. We would note that a badly received policy launch by Theresa May during the 2017 election campaign saw a similar 20% poll lead evaporate, and with it her Parliamentary majority, an outcome would see election jitters climb if repeated. Given this, while our base case is for some modest sterling upside heading towards the election, risks of a selloff are set to be elevated today.


Yesterday’s three tenths USDCAD selloff belies the mass of developments that loonie traders had to work through. While US CPI and yesterday’s Fed meeting led price action and were a net boost for the loonie against the dollar, there also were some notable interventions by BoC Governor Macklem, speaking alongside the ECB’s Nagel. First, he suggested that “with further and more sustained evidence that underlying inflation is easing, monetary policy no longer needs to be as restrictive as it has been.” Second, he reiterated a point from his press conference earlier this month, that the difference in policy rates between the US and Canada is nowhere near the limit of divergence. This is notable when set against a Fed that just last night signalled one rate cut is expected by the FOMC in 2024. As we see it, Macklem is keeping the door open to ease multiple more times before the Fed starts to ease policy. With this in mind, and given our view that it is still too early to turn bearish on the dollar, growing rate differentials should mean that the broad direction of travel should be towards further USDCAD upside over the next few months, though we will be keeping an eye on speeches by Deputy Governor Kozicki at 14:35 BST, and Governor Macklem at 18:00 BST for further confirmation.



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