Written by Convera’s Market Insights team
Dollar calm before Powell’s testimony
George Vessey – Lead FX Strategist
The US dollar dropped against a basket of currencies for a third day running as US services industry growth slowed slightly in February amid a decline in employment despite new order rising to a 6-month high. The dollar index fell towards its lowest level in a month as 2-year yields erased Monday’s gains.
The US ISM services index for February provided a mixed bag of results for the sector that accounts for more than two-thirds of the economy. The headline index slipped to 52.6 last month from 53.4 in January and below the consensus forecast of 53.0. A reading above 50 indicates growth in the services industry, so the data was consistent with continued economic expansion. Plus, a measure of new orders received by services businesses increased to 56.1, the highest level since last August. Production accelerated as a result, with a measure of business activity jumping to a 5-month high of 57.2 from 55.8 in January. On the flip side, companies are increasingly cutting their workforce with the employment component dropping to 48.0, marking the second sub-50 print in the past three months, while the 6-month moving average also dropped below the 50 line. It appears the labour market is cooling, but given the inverse relationship that the services employment index and non-farm payrolls have had over the past year, we cannot confidently deduce we’ll see a weaker US jobs report this Friday.
The reaction across markets saw Treasury yields slide across the curve as Federal Reserve (Fed) rate cut expectations rose modestly. Global risk appetite remains robust from the prospect of the Fed cutting this year, prompting investors to divert capital into assets that are higher yielding or more volatile – arguably part of the reason why Bitcoin hit a record high above $69k yesterday. Fed Chair Powell’s first day of testimony before Congress on the state of the US economy is in focus today, where he’s expected to reinforce the Fed will wait for more data before making any rate cuts.
UK Budget in spotlight
George Vessey – Lead FX Strategist
The British pound advanced through the $1.27 handle versus the US dollar yesterday and back above €1.17 against the euro, appearing to reap the rewards of the US dollar’s post ISM selling spree. Today, all eyes are on the UK Budget and the pound could get a jolt higher if moderate tax cuts lead to a steady rise in the UK gilt yields.
The scope of fiscal measures will be a balancing act for UK Chancellor Jeremy Hunt as the UK economy faces a stubborn inflation outlook and lacklustre growth forecasts. The government’s net borrowing position remains a focal point, balancing between economic recovery efforts and maintaining fiscal responsibility, facing the challenge of supporting public services and stimulating economic growth while managing the national debt and responding to external economic pressures. Overall, the opportunity for large tax cuts before a probable 2024 election might be less than previously thought. Especially since Britain’s economy fell into recession in the final quarter of 2023, while the market’s repricing of Bank of England (BoE) rate cuts has seen borrowing rates move higher in recent weeks, limiting Hunt’s fiscal headroom. Limited scope for tax cuts could increase bets of early rate cuts by the BoE, a scenario that could weigh on sterling.
However, large and unfunded fiscal stimulus will deepen fears of inflation remaining persistent, could cause havoc in gilt yields and also weigh on sterling. A moderately-sized tax relief package that does not trigger gilts turmoil could probably give some support to sterling though, and GBP/USD may scale its 2024 peaks nearer $1.28. The UK gilt market went into a tailspin 18 months ago, while the pound slumped to a record low against the dollar. We don’t expect the same kind of turbulence today, but there’s always scope for surprise and a trader can never say never.
Investors reluctant to take directional risk ahead of ECB
Ruta Prieskienyte – FX Strategist
The euro briefly rose against the US dollar after February’s eased US services industry growth, reaching $1.0860 – a 1-month high – before retreating amidst cautious trading ahead of key events: Powell’s testimony, the ECB’s rate decision, and US NFP, exacerbating the quiet conditions at the start of the week.
Latest data revealed that Eurozone composite PMIs hit an 8-month high, showing continued economic stabilization, with service sector growth since July, though manufacturing contracted. Regional variations persisted, with Ireland, Spain, and Italy seeing modest growth while France and Germany remained in contraction. In other developments, Eurozone PPI prices fell by 8.6% year-on-year in January, moderating from the previous month’s decline. As a result, Bloomberg Economics’ latest inflation nowcast has now dropped to 1.95% annually, a significant shift from February’s 2.6% and below the ECB’s inflation target of 2%. Despite that, the Bank’s policy markets are reluctant to pull the trigger and commence policy rate easing while they await for more data on inflation and wage growth developments to build enough confidence that inflation is indeed coming down to the said target at a sustainable pace. While no policy adjustment is expected until June meeting, investors will scrutinise language for subtle shifts in Governing Council sentiment during the meeting this Thursday as well as any adjustments to the latest staff macroeconomic projections.
The key risk events today include EZ January Retail Sales, Powell’s congressional testimony, and the BoC meeting. US developments continue to take precedence, we expect the EZ retail sales to be largely ignored by the market participants, unless they surprise to the upside. In such a case, the print would be euro supportive and could see EUR/USD appreciate to the near-term resistance of 50-day SMA at $1.0864. Meanwhile, if we BoC turns more dovish during the rate decision today, we could see EUR/CAD appreciate further from the current 4-month highs around $1.4750.
Risks lean towards a dovish BoC hold
Ruta Prieskienyte – FX Strategist
The Canadian dollar remains on the defence amid cautious investor sentiment, driven by today’s Bank of Canada’s (BoC) interest rate decision and anticipated economic data from the United States later in the week.
Since the last rate decision in January, the central bank has received mixed signals from the economy: growth has been stronger than expected, but inflation declined at a faster pace. The bank’s preferred gauge of inflation – three-month annualised median and trimmed measures – fell to 3.2-3.3% from 3.5-3.8%. Given that it is only one month’s data, however, policymakers will likely remain cautious and emphasise the need to see more numbers. With no new economic projections released with today’s rate decision, the BoC is expected to hold the rates unchanged for the sixth consecutive meeting and traders’ attention will be fixed on the accompanying statement as well as Governor Tiff Macklem’s post-decision interview. There is a material risk that the Bank turns a touch dovish during today’s rate decision, which would pose a downside risk to CAD and could see domestic bond yields dip lower. Swap pricing suggests markets anticipate the first-rate cut occurring at the June meeting, but markets have attached a 44% probability of a rate cut by the April policy decision.
USD/CAD has been trading in a tight range of $1.3550 – $1.3600 for the past week, but we see a downside risk going into today’s trading session with Powell’s congressional testimony and BoC on agenda. CAD negative surprises could see USD/CAD breach past $1.3600 mark (Dec-23 highs). Despite remaining conservative about a rebound in CAD in the near term, we continue to expect a broad-based dollar decline from the second quarter should – in our view – take USD/CAD to high 1.20s towards year-end.
Gold breaks an all-time high
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: March 4-8
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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.
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