FX market outlook

FX market outlook

Posted on Wednesday, March 6 2019 at 10:25 am GMT+0000

BoC decides as rate-hike bets evaporate; aussie drops

  • Bank of Canada meets; markets seem to be expecting a major dovish pivot, which may not materialize
  • US dollar rally revitalized by robust ISM index
  • Aussie drops to two-month lows as RBA rate cut expectations grow

BoC decides as rate-hike bets evaporate

The main event on Wednesday will probably be the Bank of Canada (BoC) rate decision. No action is expected, and since there is no press conference by Governor Poloz either, investors will scrutinize the accompanying statement for any hints on policy. It’s striking that a significant repricing of BoC rate hike expectations has taken place lately, with markets now seeing practically no chance for any hike this year, as opposed to roughly a 50% probability for one just a few weeks ago.

This shift occurred on the back of disappointing Q4 GDP data, which sparked speculation the BoC will follow in the Fed’s footsteps and adopt a ‘patient’ approach, signaling it will pause rate hikes until – and if – the data pulse recovers. While such a shift may indeed take place further down the road, it may be too early for the BoC to signal as much today. It seems a little exaggerated for the Bank to completely change course on a single disappointing data set, especially from a quarter where growth was weak globally, and considering that 2019 data have been solid so far. Hence, if the BoC retains an iota of optimism today and keeps a future hike on the table, that may come as a hawkish surprise, and perhaps help the loonie to rebound.

Robust ISM non-manufacturing index refuels dollar rally

The US dollar index – which measures the greenback’s performance against a basket of six major currencies – rose for a fifth consecutive session on Tuesday, propelled higher by encouraging US data. The ISM non-manufacturing PMI for February clocked in at a remarkable 59.7, far exceeding the forecast for a more modest increase to 57.3, and likely calming some fears around the US economy. Although still largely non-existent, market implied odds around Fed policy entered the green once again, indicating a faint probability for a hike this year, as the robust print amplified the narrative for a rebound in growth.

Alas, US stock markets were not impressed, closing marginally lower in an uneventful session, as even the slight revival of rate-hike expectations was enough to curb the appeal of riskier assets. Today, traders will keep their eyes on the ADP employment report for February, which is considered a tracker of the all-important nonfarm payrolls print due on Friday, as well as on a speech by New York Fed President Williams (FOMC voter) at 18:00 GMT.

Aussie gets hammered as GDP disappoints, rate-cut bets soar

The Australian dollar is the worst performer among the majors early on Wednesday, after the nation’s GDP for Q4 fell short of expectations overnight. Real growth came in at 2.3% on a yearly basis, missing the forecast of 2.5%. Aussie/dollar fell to a two-month low in the aftermath, as the probability for rate cuts by the RBA this year soared. Specifically, a quarter-point rate cut by year-end is now more than fully priced in, with investors even assigning a ~12% chance for a second one, according to Australia’s overnight index swaps.

While understandable given that incoming data have generally been on the disappointing side lately, this pricing still seems extreme in the sense that it appears to be far too dovish far too early. A potential US-China trade deal would eliminate a major downside risk facing the Australian economy, and while the RBA may still cut rates if the domestic outlook softens, doing so twice this year may be a bit of a stretch. Against this pessimistic backdrop, Australia’s retail sales for January that are due early on Thursday (00:30 GMT) may be crucial.