Written by Convera’s Market Insights team
Loonie falls as markets eye BoC decision
Ruta Prieskienyte – Lead FX Strategist
The loonie slipped alongside other commodity-sensitive G10 currencies due to a bout of risk aversion and falling oil prices. Amid a quiet economic calendar, investors are eagerly awaiting the Bank of Canada’s (BoC) interest rate decision tomorrow, where the central bank is expected to deliver a back-to-back 25 basis point cut, making it the most dovish advanced central bank on the street.
Like many other central banks, the BoC is currently in a data-dependent mode. Subdued economic growth, easing employment pressures, and lower inflation are the three key criteria for a back-to-back rate cut, but the decision may not be straightforward. On one side, a downside surprise in headline inflation and expectations of additional favourable news in the near term argue for more cuts. However, the disinflation process is no longer broadening, and services and core inflation measures are showing signs of stickiness. With the expectation of a cut in tomorrow’s meeting fully priced in by the swaps market, USD/CAD appreciated for the past nine consecutive trading sessions, climbing to a five-week high of mid-$1.37. If the market expectations were to materialise, we foresee further CAD weakness but expect the extent of it to be contained.
The cut in Q3 has been priced in for a while, and speculative positioning is still overly CAD bearish, suggesting crowded positioning. Unless we see a stark slowdown in economic momentum or further guidance of near-term easing from the Governing Council than what is currently priced in by the markets, the damage should be limited.
The one-week USD/CAD risk reversal skew, an options-implied gauge of short-term sentiment, has widened to 0.27 vol in favour of calls, indicating markets are betting on further CAD weakness in the near term versus the dollar. The overnight options volatility is currently trading at a one-week high of 7.33%. The implied volatility on a one-week 25-delta butterfly option has trended upwards from the July trough but remains in line with the year-to-date average, indicating an absence of market stress going into the tomorrow’s rate decision.
Pound appears vulnerable to a correction
George Vessey – Lead FX Strategist
In parallel with GBP/USD stretching to a fresh 1-year high above $1.30 last week, bullish bets in the British currency climbed to a record high last week. Already we’ve seen a minor correction lower in sterling, but amid the overcrowded GBP speculative positioning leading into the Bank of England’s (BoE) rate decision next week, sterling appears vulnerable at these levels.
Non-commercial traders, i.e. hedge funds, asset managers and other speculative market players, increased their net long position on the pound to an all-time high last week, according to Commodity Futures Trading Commission data. The positioning reflects the optimism around the UK’s better-than-expected economic performance so far this year, relative political stability with a majority Labour government and the currency’s appeal to carry traders as the BoE has delayed cutting interest rates. It’s the latter – carry trades – based on the pound’s high yields relative to other currencies, that could be set to uncoil as a period of ambiguous monetary policy beckons in conjunction with the eagerly-watched US presidential election. FX volatility has been in the doldrums for some time, promoting the carry trade strategy, but if the risk of bigger price swings starts unnerving investors, high yielding currencies with greater sensitivity to risk sentiment – like GBP – will likely feel the pain. Indeed, with the Fed and BoE meetings due next week, the 2-week implied volatility gauge has jumped to its highest in a month.
Meanwhile, money markets assign a 40% probability of a BoE quarter-point interest rate cut in August, which is another reason for bullish GBP traders to be wary. Because if the BoE does catch markets off guard with a cut, sterling could weaken sharply. The 200-week moving average at $1.2850 is our first key support level in focus.
Low FX cadence favours euro
Ruta Prieskienyte – Lead FX Strategist
The common currency’s gains against its commodity-backed G10 peers were precisely balanced against outflows versus the yen, leaving the broad euro index flat at the start of the week. European bonds edged lower, slightly underperforming US Treasuries, while equities continued to climb after US President Joe Biden ended his re-election campaign and endorsed Vice President Kamala Harris.
Breaking down the FX performance, EUR/AUD climbed to a fresh monthly high, extending the month-to-date gain to 1.7%, amid lower Aussie demand due to China’s unexpected short-term rate cut. In fact, the pair is on track for its first monthly appreciation since February and the largest such gain since August 2023. EUR/USD benefited in a low-volatility environment, a feature prevalent for the pair throughout most of 2024, edging marginally higher to the top of $1.08. Money markets are pricing in around 60 basis points of rate cuts by the Fed through year-end, compared with 45 basis points by the ECB. As long as the markets remain calm, we foresee the euro benefiting from the relative rate differential advantage. If volatility picks up, however, the euro is one of those currencies at risk of depreciating.
On the calendar today, the flash Eurozone consumer confidence is expected to improve for a seventh consecutive month. However, there is a risk of a downside surprise as the Eurozone soft economic data may be impacted by the fallout of the French parliamentary elections. Also on the docket today is the ECB’s Lane speech due shortly this morning. Given an eight-week gap between the July and the next ECB policy rate decision meeting, we are not expecting guidance from the Bank’s Chief Economist beyond the official communication from last week as the Governing Council waits further evidence of easing inflationary pressures.
Japanese yen up well over 1% vs. peers
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: July 22-26
All times are in BST
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
