FX Update : Narrowing rate differential between the Fed and other major central banks brings USD off its highs

FED : Market Bias - Hawkish

• Fed likely to be be hawkish in raising the rate this week to 50 bps as the data from last week showed a healthy US economy.
• PMI rose to 56.5, and October factory orders rose by 1% and goods and service trade balance posted a deficit of $78.2 billion which all beat market expectations.
• The US will report Retail Sales data on Thursday along with industrial production with both expected to show weakness compared to prior month.
• The bureau of labor statistics reported the annual PPI declined to 6.2% in November from 6.7% in October but still higher than the market expectations of 6% helping the USD to strengthen.
• Risk to Market Bias: Additional easing of COVID-19 curbs in China provide support to global risk sentiment and continuing the weakening dollar trend. A holiday season pause in fighting in Ukraine provides a window for peace talks sapping safe haven dollar support.

Market Bias: Weaker

•  With a 50bps rate hike fully baked in, all eyes will be on the Bank of England’s (BoE) 2023 rate hike outlook when they meet on Thursday. BoE interest rate outlook may strengthen sterling if more aggressive than the Fed’s forecast.
• A pause in the recent USD decline to a six-month high of 1.2344 was capped amid a relatively quiet last week.
• BoE interest rate decision may strengthen sterling if the Fed’s forecast is lower.
• Although the pound has risen 10% since September, there is still a risk that structural economic and balance of payments weakness could cause volatility
• Risk to Market Bias: This week’s GDP and Industrial data is higher than market expectation.

Market Bias: Weaker

• The European Central Bank (ECB) meets this week with markets expecting a 75bps increase. A possible hike of only 0.50% may cause euro weakness.
• While ECB officials have suggested recession/increased unemployment is inevitable they may still lag the Federal Reserve causing a drag on any euro appreciation.
• Crude Oil prices edged lower in the past week, reducing some pressure on European energy costs.
• Retail Sales in October were down by 1.8% MoM and declined by 2.7% YoY indicating a weaker economy.
• Risk to Market Bias: War tends to be inflationary with sanctions and oil price caps contributing. The ECB may have to become more aggressive with its rate hikes eventually catching up to the Federal Reserve and leading to some euro strength.

Market Bias: Weaker

• West Texas Intermediate (WTI) trades at its lowest levels since December 2021 sapping any CAD strength.
• Bank of Canada’s 50 bps rate hike last week did little to alleviate the decline of the loonie which is 1.4% weaker since last Monday. Policy makers hinted at a pause in rate hikes.
• Bearishness around the Canadian dollar may see additional weakness before year end however and many market participants consider CAD to be oversold.
• Risk to Market Bias: Fed stays on its current rate hike path and higher-for-longer does not boost USD vs. CAD.

CNY

Market Bias: Stronger

• China’s relaxation of COVID restrictions lifted the broader market sentiment despite the country’s much weaker imports (-10.6%) and exports (-8.7%) for November.
• China's Inflation has landed at 1.6% vs.1.0% as expected, and Producer Price Index (PPI) has contracted by 1.3% compared to market expectation of 1.5%. The combination of weak economy and low inflation could lead to more rate cuts by the Peoples' Bank of China  (PBOC) causing the yuan to weaken.
• The Central Economic Work Conference next week may see Chinese officials provide more support to the beleaguered property sector.
• Risk to market bias: The combination of weak economy and low inflation could lead to more rate cuts by the PBOC causing the yuan to weaken.

 Market Bias: Mixed

• PPI for November came in at 9.3% vs the 8.8% expected. So far, PPI data has far exceeded Japanese CPI providing relief to the Bank of Japan which aims to keep interest rates low.
• The Japanese yen is up over 8% vs. the US dollar since November 1 mostly on overall dollar weakness.
• Japan imports much of its energy so lower fuel costs have resulted in less yen being sold to buy oil.
• Risk to Market Bias: Fed is less hawkish and decreasing import prices that Japan is currently paying.