Written by Convera’s Market Insights team
Dollar steady as Fed meeting looms
Boris Kovacevic – Global Macro Strategist
The US dollar index (DXY) held inched higher around the 103.80 mark as the yield on the US 10-year Treasury note was little changed around 4.3% to kick off the week. Investors are gearing up for the Federal Reserve’s (Fed) monetary policy decision on Wednesday, expecting interest rates to remain unchanged but eager for new economic projections and clues about the timing and scale of rate cuts this year.
Market pricing is now finally back in line with the FOMC’s own rates projections, published via the dot plot back in December, showing three rate cuts for 2024. The probability of the Fed even delivering less rate cuts than this base case has risen from zero to 35% since the beginning of February as the excessive easing bets have been pared back. With government bond yields rising in every single trading session last week against the backdrop of the inflation surprises, discussions have emerged about the upcoming dot plot this week showing only two rate cuts for the year. While not our base case, such a revision remains a threat for investors holding risk sensitive assets hoping for a quick pivot from the Fed. Still, we do think that the re-pricing of easing expectations is approaching a limit on the downside as the disinflation trend continues in the second quarter.
Our analysis shows that on Fed decision day, the USD tends to depreciate against its G10 peers. Although the DXY has climbed around 2% this year, as markets scale back their expectations of Fed policy easing, unless it reclaims the 105 threshold in the wake of a potentially hawkish Fed this week, we think the DXY’s peak for 2024 may already be behind us.
Canadian dollar retreats ahead of domestic CPI print
Ruta Prieskienyte – FX Strategist
The Canadian dollar weakened to below $1.3550 against the US dollar, approaching a 2-week low, as pessimism continues to mount over potential Fed rate cuts following February inflation data, which bolstered the Greenback. The yield on the Canadian 10-year government bond rose above 3.60%, hitting a five-week high, tracking the upward movement of US Treasuries. Meanwhile, the Canadian stock market index edged lower as investors awaited Canada’s CPI report due later this morning.
The latest data showed that the headline CPI inflation decelerated from 3.4% y/y in December to 2.9% y/y in January, just within the Bank of Canada’s (BoC) 1%-3% target range. Excluding elevated mortgage interest costs, inflation slowed to just 2% y/y in January. However, there are expectations for an uptick in Canadian consumer prices for the February print, with markets expectations pointing towards a 3.1% y/y headline print and slightly surpassing January’s 2.9% increase. Such a print would mirror the trends observed in many of G10 nations, most notably the US, and would support Governor Tiff Macklem’s concerns about the persistence of underlying inflation.
A downward surprise to February’s CPI print could strengthen the argument for potential interest rate cuts by the BoC in the next few months, further appreciating USD/CAD towards its 2024 high of $1.3600. A rebound in the CPI, on the contrary, might provide some support to the Canadian Dollar, although to a limited extent. With FOMC rate decision looming just the day later, investors might be hesitant to trade around the Canada CPI event and instead opting to wait until after Fed’s decision. USD/CAD overnight ATM options for today are below their long-term trimmed average, implying markets are not expecting an increase in today’s volatility above historical levels. As a result an unexpected inflation results would be required to cause a significant increase in realized volatility around USD/CAD pair during today’s trading session.
Limited bullish euro potential ahead of FOMC
Ruta Prieskienyte – FX Strategist
Financial markets started the week cautiously, as multiple central banks will announce their decisions on monetary policy in the upcoming days. EUR/USD stumbled below its support level at $1.0880 (14-day SMA) as the investors trimmed Fed’s June rate cut bets.
As expected, the final Eurozone inflation rate release for February was confirmed at a 2.6% y/y (3-month low), showing disinflation is continuing in the euro area. Lower inflation is necessary, but not a sufficient condition for the European Central Bank to ease its policy rates from historic highs at 4%. The Governing Council is also laser-focused on wages to judge whether domestically generated cost pressure is abating in a sustainable way. The latest data for released this morning revealed that Eurozone labour costs rose by 3.4% y/y in Q4 2023, the slowest pace since Q3 2022, and below market expectations of 4.6%. Although the moderation in pay growth strengthens the case for a June rate cut, interest rate traders are hesitant to change positioning for ECB rate pricing ahead of the FOMC meeting tomorrow with 85bps of cuts priced in by year-end. 65% probability of a June rate cut remains largely unchanged from the day before as well.
What can we expect going into the day FOMC decision week? Over the past 14 meetings, the day ahead of the Fed decision, EUR/USD tended to close within 0.3% band of the day’s bid open with no statistically significant trend to support marginally bullish nor bearish trend. With EUR/USD overnight ATM options not pricing in an increase in volatility either, we are expecting the euro to remain neutrally positioned against the US dollar, with investors hesitant to put on large last-minute positions. Thus far, markets have yet to react to better-than-expected Eurozone wage growth report and German ZEW survey and appear to be on standby for the FOMC on Wednesday. Today’s target for EUR/USD is $1.0840 – $1.0900, with the pair supported by 200-day SMA at $1.0838, but sentiment remains bearish.
CAD/JPY up 1.8% from last week
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: March 18-22
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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.
