FX Weekly: Risk-on tone continues as Fed pause nears while USD shows continued softness

Market Bias: Bearish

• Last week’s US CPI data for both MoM and YoY came in right as expected, indicating a deceleration in prices as inflation pressures slow. The dollar sold off in response.
• Hawkish comments out of the Fed – Bullard, Barkin, and Harker all made comments that favored increasing rates beyond 5%.
• This week’s data on housing and unemployment claims are expected to show slight declines, while manufacturing is predicted to improve. Strong data readings could cause another risk rally as seen after CPI releases, which could push the USD lower.
• Risk to current market bias: Unexpected weak data readings this week could surprise markets and trigger a risk-off sentiment, which would strengthen the USD. An increase in Fed hawkishness or poor corporate earnings could have the same effect.

Market Bias: Bullish

• Bank of England’s (BOE) Catherine Mann made several hawkish comments last week, indicating that the BOE will continue to raise rates despite recession risk and prioritize bringing inflation down to its target rate of 2%.
• CPI YoY this week is expected to decrease nominally, from 10.7% prior to 10.6%. A reading in-line with expectations or better could give even more support to the BOE to continue raising rates, which would strengthen the pound.  
• The UK is facing the added challenge of an aging population, thus contributing to lower productivity compared to their G7 peers. This will be an added headwind to economic growth on top of the BOE’s consensus to aggressively hike rates further.
• Risk to current market bias: A shift in BOE priorities from the 2% inflation target to other measures, such as supporting the labor market or economic output, would likely weaken GBP.

Market Bias: Bullish

• The European Central Bank (ECB), which has taken a dovish approach to inflation until recently, has turned hawkish. Like the BOE, bringing inflation down to target is a top priority.
• Unusually warm winter weather has been a saving grace amidst the energy crisis, as natural gas prices have decreased due to lower demand.
• Bolstering ECB hawkishness is consumer sentiment around inflation, which has largely receded back to the long-term norm despite high prices, according to an ECB survey.
• The EUR in particular has seen steady gains against the USD post-CPI reading, now at the strongest level since last April.
• Risk to current market bias: A shift in ECB sentiment which deprioritizes bringing inflation down would likely weaken EUR.

Market Bias: Bullish

• Like most currencies, CAD has strengthened recently vs. the US dollar.  Mostly due to the US CPI reading but also due to a rally in commodity prices and the expectation of 25bps rate hike by Bank of Canada on Jan 25. This could be the last hike before Canada reaches their target interest rate.
• Canada CPI reading this week is the last big data point before the Jan 25 BOC meeting, and it has been trending downward since June.
• Risk to current market bias: Weak economic data around employment or the housing market could cause a shift in BOC sentiment and lead to a pause in rate hikes, which would weaken CAD.

JPY     
Market Bias: Bullish

• The BOJ has finally taken a hawkish turn. After not taking any significant measures to combat inflation, Yomiuri news reported that the BOJ will inspect the side effects of loose monetary policy and may consider adjusting their bond purchase program next week.
• BOJ is expected to raise rates by 50bps in March – this has potential for investors to flock back to JPY investments and cause significant strength to the currency. JPY has already strengthened 17% vs. USD since October.
• Risk to current market bias: The BOJ is expected to pivot when Kuroda departs in April, although with much uncertainty around what exactly the pivot entails. If it is less hawkish than expected, a weakening of JPY is possible.