rate expectations

FX Daily: Trading the 50-50 risk Despite the very strong headline US May payroll figure, rising unemployment and declining wage inflation are keeping markets from fully pricing in a June Fed hike (we expect a hold). Barring a big ISM services surprise today, the lack of other key inputs before next week’s CPI could keep the dollar capped. The RBA decision tomorrow is also a 50-50 decision     USD: Not enough to price in a June hike The blowout May headline payroll number added fuel to the narrative of an extra tight US labour market, but the coincidental rebound in unemployment to 3.7% and slowdown in wage growth kept markets from going all-in on a June rate hike by the Federal Reserve. As discussed in this note by our US economist, payrolls and the unemployment rate are calculated through different surveys: the former by employers, and the latter by households. In practice, firms and households conveyed very different messages about the direction of the US labour market in May.   We think that, when adding the cooling off in wage inflation, and considering the diverging views within the FOMC, the case for a pause at the 14 June meeting should prevail. The last big risk event before the rate announcement is the 13 June CPI reading, while today’s ISM services figures (the consensus expects a mild improvement) might have a somewhat contained impact on rate expectations, barring major diversions from expectations. The FOMC has already entered the black-out period.   Markets are currently pricing in a 25-30% implied probability of a hike in June, while 21bp are factored in by the end-July meeting. We suspect that the pricing may not vary considerably, or that the narrative of a “50-50” chance of a hike in June may prevail until the CPI numbers next Tuesday – and barring a surprise there – into the FOMC announcement itself.   With markets not having received enough compelling evidence from the May jobs report to price in more than a 50% probability of a June hike, we feel that two-year USD swap rates, which rebounded to 4.73% after having declined to 4.51% on Friday, may struggle to find much more support this week.   Add in a period of potential market sentiment stabilisation now that the debt-ceiling saga has ended and we think the dollar's bullish momentum may dwindle into the FOMC meeting.   We see a higher chance of DXY stabilising around 104.00 or pulling back to 103.00. Some pro-cyclical currencies could emerge as outperformers in this period: the Canadian dollar, for example, may stay supported now that Saudi Arabia announced another one million barrels a day of oil production cuts and even if the Bank of Canada stays on hold on Wednesday, as long as it keeps the door open for a potential hike down the road.    

A hawkish hold from the Bank of Canada next week We expect the BoC to leave the policy rate at 4.5% next week, but after stronger-than-expected consumer price inflation and GDP and with the labour data remaining robust we cannot rule out a surprise interest rate increase. The market is pricing a 25% chance of a hike on 7 June, and a hawkish hold should be anough to keep the Canadian dollar supported.   Canadian resilience means a rate hike can't be ruled out The Bank of Canada last raised rates on 25 January and have held it at 4.5% ever since. The statement from the last meeting in April commented that global growth had been stronger than expected and that in Canada itself, “demand is still exceeding supply and the labour market remains tight”. The bank warned that it was continuing to “assess whether monetary policy is sufficiently restrictive and remain prepared to raise the policy rate further” to ensure inflation returns to 2%.   Since then we have had additional warnings from Governor Tiff Macklem that the bank remains concerned about upside inflation risks with the latest CPI report showing a month-on-month increase in prices of 0.7% versus a consensus forecast of 0.4%, resulting in the annual rate of inflation rising to 4.4%. The economy added another 41,400 jobs in April, more than double the 20,000 expected with wages rising and unemployment remaining at just 5%. The resilience of the economy was then emphasised further by first quarter GDP growth coming in at 3.1% annualised, beating the 2.5% consensus growth forecast. Consumer spending was the main growth engine, rising 3.1%.     But we favour a hawkish hold – signalling action unless inflation softens again soon Nonetheless, the BoC accept that monetary policy operates with long and varied lags and continue to believe that “as more households renew their mortgages at higher rates and restrictive monetary policy works its way through the economy more broadly, consumption is expected to moderate this year”. This will help to dampen inflation pressures and with commodity price softening we still believe that inflation can get close to the 2% target by the early part of 2024.   With the US economic outlook also looking a little uncertain, we doubt that the BoC will want to restart hiking interest rates unless it is certain that inflation pressures will not moderate as it has long been forecasting. Consequently we favour a hawkish hold, signalling that if there isn’t clearer evidence of softening in price pressures it could raise rates again in July.     The loonie's resilience can continue The Canadian dollar has been the best G10 performing currency in the past month, largely thanks to its high beta to the US economic narrative and a repricing of Canada’s domestic rate and growth story. These factors have outshadowed crude’s subdued performance in May and some risk sentiment instability.   A hawkish tone by the Bank of Canada at the June meeting is clearly an important element to keep the bullish narrative for CAD alive. As shown below, the recent repricing in Fed rate expectations caused a rebound in short-term USD swap rates relative to most currencies (like the euro), while the USD-CAD 2-year swap rate differential has remained on a declining path also throughout the second half of May.     As long as the BoC does not push back against the pricing for a hike in the summer, we expect CAD to remain supported. Some lingering USD strength in June can put a floor around 1.33/1.34 in USD/CAD, but we expect a decisive move to 1.30 in the third quarter and below then level before the end of the year.  

For the Fed, the market is currently pricing a less than 30% chance for a hike on Wednesday next week, but it is seeing an 80% chance of a 25bp hike in July. Our house view is that the Fed is already at its peak policy rate, though with the caveat that a higher CPI reading could still eke out a hike next week. In any case, the Fed is likely to leave the door open to more, and in a hawkish no-hike scenario this could be reflected in the dot plots, the FOMC members’ projections of the Fed funds rate     In EUR money markets the pricing of the policy path looks pretty much aligned with the ECB’s own communication. A hike is a done deal for next Thursday and followed by at least one more in the following two meetings in July and September. This is largely in line with our economists’ prediction which sees two consecutive hikes as the base case.   To evaluate central banks’ effective policy stances one can also revert to OIS real rates. At levels closer again to the top of recent ranges, these suggest relatively tight policy circumstances, especially judged against the backdrop of the more mixed macro signals of late. This should give policy makers some comfort with regards to the reception of their recent communication, where the “skip”-narrative, bolstered by the Bank of Canada’s example certainly has helped to curb a more pronounced pricing of cuts further down the line.     Supply can add a bearish tilt especially early in the week The US treasury will issue US$40bn 3Y and US$32bn 10Y bonds on Monday followed by a US$18bn 30Y bond sale on Tuesday. The setup around the CPI release and ahead of the FOMC meeting may warrant extra price concessions from dealers to absorb the duration risk. At the least, this could inject some extra volatility into the market.   Primary market activity will also remain elevated on the eurozone sovereign side. While it was syndicated deals pushing issuance volume higher this week, next week’s scheduled auction supply could already push volumes closer to €40bn - we will see Italy, Germany, Finland, the Netherlands as well as France and Spain all being active with bond sales.   Today's events and market view Today’s session is light on data which suggests some prepositioning into next week’s events. In US markets also with a view to Monday’s and Tuesday’s Treasury supply. Data remains crucial, both for market and central banks as it increasingly guides their policies. While it was the jobless claims data that triggered a more noticeable retracement of yields, their levels closer to the upper end of recent ranges still signal a preoccupation with concerns around stickier inflation - Tuesday's US CPI release looms large.   While we see only a limited ability of the ECB to move especially longer rates higher, while the skip narrative that has been pushed by the Fed and exemplified by the BoC should also prevent markets from prematurely jumping onto hopes that the Fed could be done. A Fed surprise hike could have more of an impact and invert curves as it further plays into the fears that more tightening could be needed to rein in inflation.    

FX Daily: Data sensitivity at its highest A jump in US jobless claims sent the dollar lower across the board yesterday, confirming how FX markets have an extremely elevated sensitivity to data in this moment. Quiet calendars in the US and eurozone mean we could see EUR/USD stabilise, but watch Canada’s jobs numbers. Elsewhere, higher inflation has endorsed our call for more Norges Bank tightening.   USD: Jobless claim jump hit the dollar Currency markets continue to show very elevated sensitivity to data: yesterday, the increase in US weekly jobless claims to 261k against a median estimate of 235k sent the dollar weaker across the board. Lay off numbers have been rising consistently over the past few months and we could now start to see those finally trickle through to the initial jobless claims data. We must remember that there is always a period of time between lay off announcements and the actual job being cut and often no claim can be made until all severance payments have been finalised.   The Fed funds futures curve shows that markets have only marginally scaled back rate expectations after the Bank of Canada's surprise hike triggered a fresh round of hawkish bets. There are currently 7bp priced in for June, and 19bp for July, around 3bp lower (for both meetings) compared to Wednesday.   Yet, if we exclude CAD – which is trading in tandem with USD at the moment – the dollar fell around 0.7%-1.0% against all G10 currencies yesterday. It is a testament to that big FX sensitivity to data and rate expectations, and one of the reasons behind our bearish USD view for the second half of the year, when we expect both data and rates to turn negative for the greenback.   The lack of data releases in the US may offer some stabilisation to the dollar around current levels today (hovering around the 103.50 handle in DXY). Elsewhere, it’s worth keeping a close eye on Canadian jobs numbers, now that a July back-to-back hike is a tangible possibility. Consensus is looking at a solid 21k headline read, but with unemployment ticking higher from 5.0% to 5.1% and wage growth cooling off marginally, in line with what we saw in the US May jobs figures.    

GBP: Staying supported into the BoE meeting We are entering a few days of calm in the UK calendar after a slew of key data releases. Yesterday’s GDP data endorsed the recent re-rating of the UK’s growth outlook but hardly mattered for the Bank of England as much as the inflationary signals sent from the jobs and wage growth figures earlier this week.   Bank of England rate expectations were marginally scaled back after the Fed meeting, but still imply five 25bp rate increases from current levels before the end of the year. It’s important to note how the higher gilt rates are by themselves starting to have their tightening effect on the economy. Mortgage market distress is the most direct example, with major lenders hiking rates and some pulling mortgage offers following the recent repricing of tightening expectations.   It is, still, too early to factor that – or any implications for the housing market – into sterling, which will probably continue to find support into next week’s CPI and Bank of England meeting. EUR/GBP could move closer to the 0.8500 key support after today’s ECB decision.

We doubt the BoE would endorse a 6% Bank Rate at this stage But not pushing back against rate expectations is not the same thing as validating them. And we have strong doubts that the BoE will take rate hikes as far as markets expect. Admittedly there’s no hard-and-fast rule that tells a central bank how high is too high. The BoE’s models have suggested that inflation will be well below target if rates were to go to the 5% area – let alone 6% – although policymakers have made it clear that they’re sceptical of these forecasts right now. But if we look at the mortgage market – the main transmission mechanism for interest rates – then 6% rates would mean a homeowner with a 75% loan-to-value ratio would, on average, be paying close to 40% of their disposable income on repayments. That compares to roughly 30% at the peak going into the 2008 financial crisis. The difference between now and then is that the share of households with a mortgage has fallen, and more people own their home outright now. And more importantly, around 90% of mortgages are fixed – predominantly for five years – a huge sea change compared to 10+ years ago when most were on variable rates. The result is that the length of time rates stay elevated is now arguably more important than the level, and the impact of 5%+ mortgage rates for a prolonged period would be large. The BoE is also right to highlight that the impact of past rate hikes is only now beginning to bite as a greater number of mortgage holders refinance.   Homeowners will be paying close to 40% of their average disposable income on repayments after refinancing    

FX Daily: A hawkish ‘skip’ by the Reserve Bank of Australia The RBA decided to focus on decelerating inflation rather than the strong labour market and kept rates on hold overnight. Still, it reiterated a data-dependent approach and signalled openness to more tightening ahead. In general, it should be a quiet day in FX today due to the US national holiday, but things will get hectic again from tomorrow.   USD: National holiday today, but volatility to pick up from tomorrow The week has started without very clear direction dynamics in dollar crosses, largely due to reduced flows in US markets around the Independence Day holiday: US bond and equity markets are closed and there are no data releases, so expect another quiet day in FX. Yesterday, the ISM manufacturing index was released and came in at 46.0, below consensus expectations. The print was in contractionary territory (i.e. below 50) for the eighth consecutive month and hit its lowest level since May 2020. It’s worth noting that ISM manufacturing has been a historically accurate leading indicator of GDP dynamics and it currently points to a substantial slowdown.   This week, markets will once again need to filter their rate expectations for the evidence offered by data releases in the US. The reaction to the ISM manufacturing index has been limited due to reduced volatility around the US holiday, and also because the ISM services (out on Thursday) has been a bigger market mover. USD-crosses volatility will pick up again tomorrow when the focus will shift to FOMC minutes.

ADP employment surprises with a huge gain of 497,000 On Friday, US releases nonfarm payrolls and Canada publishes the employment report Nonfarm payrolls are expected to fall to 225,000, Canada projected to add 20,000 jobs The Canadian dollar is in negative territory on Thursday. In the North American session, USD/CAD is trading at 1.3360, down 0.58%. The Canadian dollar has slipped over 1% since Wednesday.   ADP employment shows a massive gain  After the Fed minutes on Wednesday, the markets were awaiting the nonfarm payrolls on Friday. The ADP employment report, which precedes nonfarm payrolls, often gets no more than a cursory glance as it’s not considered a reliable precursor to the NFP. Thursday’s release, however, was simply too large to ignore. The ADP reported a gain of 497,000 in June, up from 267,000 in May and well above the consensus of 228,000. US nonfarm payrolls are expected to move in the opposite direction of the ADP report, with a consensus of 225,000 in June, down sharply from 339,000 in May. After today’s ADP shocker, Fed policy makers will be hoping that nonfarm payrolls decline as expected. If nonfarm payrolls follow the ADP lead and climb sharply higher, the Fed may be forced to raise rates more than expected in the second half of the year to cool the hot labour market. The money markets have repriced rate expectations for July following the ADP release. The probability of a 0.25% hike is currently at 94%, up from 86% prior to the ADP report. Fed Chair Powell has hinted at one more rate hike after July, but a September hike will be more likely if nonfarm payrolls rise on Friday. The ADP report grabbed all the headlines, but other employment numbers on Thursday could indicate that the labour market is slowly weakening. Unemployment claims rose from 236,000 to 238,000, higher than the consensus estimate of 245,000. As well, JOLTS Jobs Openings fell from 10.32 million to 9.82 million, shy of the consensus estimate of 9.93 million. The ISM Services PMI may be another headache for the Fed, as it jumped in June to 53.9, well above the May reading of 50.2 and the consensus estimate of 51.2 points. The report indicates that business activity is expanding and the economy remains strong, despite the Fed’s aggressive tightening cycle. Canada releases the June employment report on Friday. The economy is expected to rebound with 20,000 new jobs in June, after a loss of 17.3 thousand in May. The unemployment rate is projected to rise to 5.3% in June, up from 5.2% in May. . USD/CAD Technical USD/CAD is testing resistance at 1.3318. Next, there is resistance at 1.3386 1.3217 and 1.3149 are providing support  

The recent US Consumer Price Index (CPI) reading has caused some ripples in the market, prompting discussions on its implications for future monetary policy by the Federal Reserve. We reached out to Marco Turatti, an expert in the field, to shed light on the matter. According to Turatti, the CPI numbers came as a downside surprise, with both the headline and core components showing a decline on both monthly and annual bases. This decline in prices has been even faster than the previous rise, with the Producer Price Index (PPI) leading the way. Despite the rally in equities and bonds, Turatti notes that there has been minimal change in rate expectations. The likelihood of a 25 basis points hike this month remains unchanged at 92%, and the terminal rate is only down by 3 basis points to an expected level of 5.37% by November.     FXMAG.COM: Please comment on the US CPI reading. What does it mean in terms of further Fed monetary policy?   Marco Turatti:  The CPI number yesterday was a downside ''surprise'' in both its headline and core components, both on a monthly and annual basis. The decline in prices is even faster than the previous rise, with the PPI leading the way. Despite the equity and bond rally, very little has changed in terms of rate expectations: the chance of a 25 bps hike this month is unchanged at 92%, as is the terminal rate, down only 3 bps to the 5.37% level expected for November (meaning a second hike is not yet priced in). Prices are going down but wages (and second hike effects) may worry: their real growth is now at the highest since March 2021 (1.2%).

EUR: ECB radio silence not helping the euro EUR/USD remains a dollar story and with the US data calendar about to pick up (ADP, ISM services, payrolls), the dollar leg should remain dominant given that most key eurozone data was already published earlier this week. We discussed yesterday the market’s reluctance to price in more than a 50% chance of another hike by the ECB, despite sticky core inflation. One thing missing may be the lack of the usual post-ECB communication re-tuning by governing council members (due to the summer season, more than anything else). The calendar of ECB speakers continues to show only Fabio Panetta tomorrow, and he is the most dovish voice, so unlikely to lift rate expectations. The US credit downgrade helped EUR/USD avert a move below 1.0950, but more pressure on the pair is definitely on the cards should US data prove robust. A test of 1.0900 by the end of the week seems feasible.

Bank of England set to raises rates to a new 15 year high European markets underwent another negative session yesterday, clobbered by concerns over weaker than expected economic activity, which in turn is raising concern for earnings growth heading into the second half of the year. Throw in a US credit rating downgrade from Fitch and the catalyst for further profit taking after recent record highs for the DAX completed the circle of negativity.     US markets also underwent a negative session, with the Nasdaq 100 undergoing its worst session since February, while the US dollar acted as a haven and the yield curve steepened. As a result of the continued sell-off in the US, and weakness in Asia markets, European markets look set to open lower later today, and while the Fitch downgrade doesn't tell us anything about the US political governance that we don't already know investors appear to be looking to test the extent of the downside in the market.     Earlier this week we saw some poor manufacturing PMI numbers which showed that the European economy was very much in recession, with disinflation very much front and centre. This has raised questions as to whether the services sector will eventually succumb to similar weakness. There has been some evidence of that in recent readings but by and large services activity has been reasonably robust. In Spain services activity is expected to remain steady at 53.4, along with Italy at 52.2. The recent flash numbers from France saw further weakness to 47.4, while in Germany we can expect to see a resilient 52, down from 54.1.         EU PPI for June is expected to slip further into deflation to -3.2% year on year. In the UK services activity is expected to slow to 51.5 from 53.7. With inflation unexpectedly slowing more than expected in June to 7.9% it could be argued that the pressure on the Bank of England to hike by another 50bps has eased somewhat, especially since the Fed and the ECB both hiked by 25bps last week.     Having seen core CPI slow by more than expected to 6.9% forward rate expectations have eased quite markedly in the past few weeks. Forward market expectations of where the terminal rate is likely to be, have slipped from 6.5%, to below 6%. It's also likely that inflation for July will slow even more markedly as the effects of the energy price cap get adjusted lower which might suggest there is an argument that we might be close to the end of the current rate hiking cycle.     The fly in the ointment for the Bank of England is the rather thorny issue of wage growth which has moved above core CPI, and could prompt the MPC to err towards the hawkish side of monetary policy and raise rates by 50bps, with a view to suggesting that this could signal a pause over the coming weeks as the central bank gets set to consider how quickly inflation falls back over the course of Q3. Such an aggressive move would be a mistake given that a lot of the pass-through effects of previous rate increases haven't fully filtered down with some suggesting that the Bank of England should pause. In the current environment this seems unlikely given a 25bps is priced in already.       In a nutshell we can expect to see a hawkish 25bps as a bare minimum, and we could also see a split with some pushing for 50bps. We could also get an insight into how new MPC member Megan Greene views the current situation when it comes to casting her vote. One thing seems certain, she is unlikely to be dovish as Tenreyro whom she replaced on the MPC.     We'll also get a further insight into the US labour market after another bumper ADP payrolls report yesterday which saw another 324k jobs added in July. Weekly jobless claims are expected to come in at 225k, while we'll also get an insight into the services sector with the ISM services index for July which is expected to come in at 53. The employment component will be of particular interest, coming in at 53.1 in June, having jumped from 49.2 in May.       EUR/USD – managed to hold above the 50-day SMA for the time being, with a break below targeting further losses towards 1.0830. Resistance currently at last week's high at 1.1150.     GBP/USD – also flirting with the 50-day SMA with a clean break targeting a move towards the 1.2600 area.  Resistance at the 1.2830 area as well as 1.3000.         EUR/GBP – continues to edge higher drifting up to the 0.8630 level before slipping back, although it is now finding some support at the 0.8580 area. We need to see a concerted move above 0.8620 to target the July highs at 0.8700/10.     USD/JPY – continues to look well supported above the 142.00 area, with the next target at the previous peaks at 145.00. Support comes in at this week's lows at 140.70.     FTSE100 is expected to open 10 points lower at 7,551     DAX is expected to open 22 points lower at 15,998     CAC40 is expected to open 15 points lower at 7,297   By Michael Hewson (Chief Market Analyst at CMC Markets UK)  

GBP: Starting on the right foot The pound has had a good start to the week, outpacing other G10 currencies: EUR/GBP was pressing the 0.8600 support yesterday. Interestingly, this was not driven by a rebound in the Bank of England rate expectations (peak rate still seen around 5.70-5.75% in January): it appeared, instead, a mirror of supported sentiment in FX, and the pound showing its ever-increasing sensitivity to risk. There will be very little on the domestic side for GBP until Friday when GDP figures are released. Expect the pound’s beta-to-risk sentiment to remain elevated for now: in the longer run, we still think markets are overestimating BoE tightening, will have to scale down expectations and EUR/GBP can climb back to 0.87-0.88

GBP: Unusually stable BoE rate expectations The data and Bank of England event calendars are empty today and tomorrow in the UK, and will only pick up again on Friday with the release of GDP and industrial production. The lack of domestic events in the UK has helped an unusual period of very stable BoE rate expectations: markets appear rather anchored to the prospect of a peak rate around 5.70-5.75% for now. EUR/GBP has faced some downward pressure, likely due to the negative impact of the Italian bank windfall tax announcement on the euro, but looks unlikely to break out of recent ranges. 0.8600 should continue to be the gravity level for now.      

EUR: Range-bound for now The EUR-USD two-year swap rate gap tightened for a third consecutive session yesterday, although by quite negligible amounts (-146bp to -140bp) compared to the massive rewidening experienced throughout July (where it had reached a -100bp peak). Despite the benign US disinflation story, it is no surprise that markets are not flooding long EUR/USD positions. That has been an already relatively crowded trade, and the recent re-pricing of growth expectations of both growth and rate expectations in the eurozone is weighing on the euro’s attractiveness. EUR/USD looks likely to keep trading range-bound (1.09-1.11) until signs of a US economic slowdown move the rate differentials back in the euro’s favour.

GBP: Volatile pricing ahead of PMIs Bank of England rate expectations have been quite volatile since the upside surprise in wages and CPI last week. The miss in retail sales on Friday saw peak Bank rate expectations as measured in the Sonia rate drop more than 10bp. Markets are currently looking at 5.95-6.0%, but today’s PMI release in the UK may well move pricing again. Consensus is expecting some slowdown in both manufacturing (already in contraction territory) and services (to 51.0). The Bank of England will also look at the details of the survey searching for evidence that price pressures are abating. EUR/GBP can make another attempt at breaking 0.8500 today, although the sustainability of sub-0.8500 levels is questionable unless markets price in more rate hikes in the UK or price out tightening in the eurozone.

UK service sector enters contraction as rate hikes begin to bite The latest UK PMIs are unquestionably bad, and will give the Bank of England pause for thought as it nears the end of its tightening cycle.   The PMIs are unquestionably bad Like the eurozone, there has been a pronounced deterioration in service sector activity in August, according to the latest PMIs. The index for this sector has slipped below the all-important 50 level, reaching 48.7. According to the makers of the PMI, S&P Global, higher Bank of England rates are beginning to do their job. For various reasons, none of this will likely lead to a contraction in third-quarter GDP. Mainly because a hefty increase in June’s monthly activity numbers gave the third quarter a decent starting point, so when you compare the average GDP across July-September, it’s likely to be higher than the three months prior even if the economy fails to grow over the summer. On top of that, the ever-deteriorating manufacturing PMI – now at 42.5 – doesn’t really tally with what the official data is telling us, and that’s partly due to a sharp improvement in car production in recent months. Overall GDP growth in the 0.3-0.4% area for the third quarter seems a reasonable base case at this stage. Still, what these PMIs do tell us is that the UK is unlikely to be able to sustain those sorts of growth figures over the coming months. That manufacturing weakness is likely to show up more evidently. And remember that much of the impact of past rate hikes is still to feed through, given the heavily-fixed nature of the UK’s mortgage market.     Poor PMIs highlight the risks of focusing on backward-looking wage/inflation data For now, the Bank of England doesn't seem to be been putting too much emphasis on the growth numbers, with its focus still almost entirely on inflation. And on that score, policymakers won’t like the references in the latest PMI press release to persistently strong wage pressures. Still, the PMIs also reveal that prices charged by corporates are increasing at the slowest rate since February 2021, and that echoes what we’ve seen in various other surveys too. Ultimately, the Bank of England appears wary about putting too much weight on survey data, while official numbers on wage growth and services inflation continue to come in higher. But much like the recent increase in unemployment and ongoing fall in vacancy numbers, today’s PMIs show that the economy does appear to be turning from a state of very modest growth to stagnation and perhaps even modest recession. As time goes on, the BoE’s laser-focus on inflation/wages, both of which are heavily lagging indicators of economic activity, means the risks of overtightening have risen. These latest PMIs have seen a big repricing of UK rate expectations this morning according to the swaps curve, and investors now see Bank Rate peaking at 5.83% – or two-and-a-bit extra rate hikes. That doesn’t seem totally unrealistic, though our own base case is that we get just one final rate hike in September. That’s premised on the services inflation numbers staging a modest improvement before November’s meeting, enabling the Bank to pause.

EUR: Lagarde can give the euro some relief ECB President Christine Lagarde probably faces a harder task than her US counterpart today. The latest PMIs confirmed the eurozone economy is heading towards a period of sluggish growth, which now makes any hawkish statement a harder sell. At the same time, Lagarde and her ECB colleagues are probably aware that the window for one last hike to curb the still non-negligible service inflation is closing fast. In other words, if the ECB pauses in September, it may well not get a chance to hike any more given the deteriorating economic outlook. As in the case of the Fed, we have already heard from a couple of ECB speakers. Ultra-hawkish member Joachim Nagel unsurprisingly said it’s too early to think about a pause and restated the bank’s data-dependent approach. A slightly more moderate Governing Council member, Boris Vujcic, also echoed such reasoning. Our perception is that Lagarde is unhappy with the market's recent scale-down of rate expectations in the eurozone (a September hike is only 40% priced in), and she may prefer to keep overlooking some evidence of worsening growth and stick with a pure data-dependent approach. Ultimately, if inflation surprises on the upside, the chances of a hike in September would rise quite significantly in our view, especially given the deteriorating growth outlook, which means that could be the ECB’s last chance to raise rates. The EUR-USD two-year swap rate differential has widened (in favour of the dollar) to the 140-145bp levels, which were last seen in February/March. We think there is room for some re-tightening after Lagarde’s speech today, and for EUR/USD to enjoy a relief rally after the break below 1.0800 saw more bearish momentum building overnight.  

FX Daily: ECB hawkish pushback to face key inflation test The ECB hawks have stepped in to revive depressed rate expectations, but markets are opting for data dependency, and EUR/USD is set to face two key risk events with eurozone inflation figures before the US payrolls this week. We expect core inflation will prove resilient enough to trigger another ECB hike, so see upside room for the pair.   USD: Things will get hectic this week It has been a slow start to the week for FX markets. Yesterday’s closure of the UK’s markets for a national holiday meant much thinner trading volumes, and the key data calendar was quite light. In the US, the only release to note was the Dallas Fed Manufacturing Index, which dropped slightly more than expected into contraction territory, confirming the slack in the manufacturing territory already signalled by other surveys (ISM, PMIs). Still, the slowdown in manufacturing activity is hardly a US-only story. We have seen a deterioration in global forward-looking economic indicators in many developed economies recently, especially in Europe. The difference now is how the US service sector is appearing more resilient than the eurozone’s, despite significantly tighter monetary policy in the US. The relative strength in US activity indicators – compared to the rest of the world and to expectations – is what has kept the dollar in demand over the past few weeks, and should remain the number one driver of USD moves into year-end. That is because the disinflationary process appears to be cementing, allowing the Fed to halt hikes and focus on growth: until data turn for the worst, however, markets will not be pricing in more cuts, and a favourable real rate (the highest in the G10) will keep a floor under the dollar. This week presents some important risk events for the dollar from this point of view. Today, the JOLTS job openings for July will be watched closely in search for signs that the labour market has started to cool off more drastically. The Conference Board consumer confidence index is also published, and expected to come in only marginally changed compared to July. Later in the week, we’ll see ADP jobs numbers (they move the market, but tend to be unreliable), and the official payrolls report. Remember that payrolls through March were revised lower (although that is a preliminary revision) by 306,000, which probably adds extra heat to this week’s release. DXY is trading around the May-June 104.00 high area. Investors may want to wait for confirmation from jobs data to push the dollar significantly higher from these levels, and a wait-and-see, flat (or moderately offered) dollar environment could dominate FX markets into Friday’s payrolls.

FX Daily: Eurozone inflation, round one Spain and Germany will release inflation figures today, and market expectations for the ECB's September meeting may already be impacted. Eurozone numbers are out tomorrow. Meanwhile, ADP payrolls are out in the US after a soft batch of data hit the dollar yesterday, while AUD is shrugging off lower-than-expected CPI figures.   USD: ADP could be inaccurate, but may move the market Two softer-than-expected data releases in the US yesterday prompted a sizeable correction in the USD 2-year swap rate yields, which fell from 4.94% to the 4.80% area. JOLTS job openings data fell to 8.8 million in July, meaning there were approximately 1.5 open positions for each unemployed worker – the lowest ratio since September 2021. The hiring rate declined marginally, but the layoff rate was unchanged. Consumer confidence figures also disappointed, with the Conference Board survey dropping from a revised 114 level in July to 106 in August. Other components of the survey also declined. The rally in pro-cyclical currencies and the dollar’s weakness across the board was a confirmation of how US activity data – even if non tier-one releases – remain firmly in the driver's seat for global currency markets. Developments in China and in the commodity sphere, while important, clearly continue to play a secondary role. Today, expect markets to focus on the ADP employment figures. These have not proven to be a very accurate estimator of the official payrolls recently but have often impacted rate expectations. The consensus is for a 195k print. Wholesale inventories and pending home sales for July, as well as the GDP and core PCE secondary release for the second quarter, are also on the calendar today. The dollar is regaining some ground this morning after yesterday’s losses, but data will determine the direction of travel today. We had called for a weaker dollar at the start of this week and we’d like to see whether eurozone inflation data boost the chances of one last hike from the European Central Bank. With markets being more convinced of no more hikes by the Federal Reserve – barring a surprise in payrolls – a re-tightening in the EUR/USD short-term real rate gap could set the tone for a weaker dollar across the world. DXY may continue its correction from the 104.00 highs and test 103.00 should eurozone inflation figures come in strong enough and US employment not surprise on the upside. 

GBP: Table top mountain The UK rates curve softened by 9-10bp yesterday on comments by Bank of England Chief Economist Huw Pill, that the policy rate profile would look more like a "table mountain" – the inference here is that high rates would be kept for longer than the need to take rates much higher per se. However, the market still prices another 50bp of tightening into next year, which is 25bp too much in our opinion. The risk of re-pricing looks greater for the BoE than the ECB curve and keeps us positive on EUR/GBP. Levels in the 0.8500/8550 area should be good for corporates to hedge GBP receivables or EUR payables.  

GBP: Data check this week The pound emerges from a difficult week where the dovish rhetoric ahead of future Bank of England decisions consolidated and markets continued to scale back tightening expectations. It must be noted that the largest contributor to the dovish re-pricing in the GBP curve has been the BoE’s own communication, which seemed to shift more in favour of a higher-for-longer rather than a higher peak. One bit of data that endorsed the dovish narrative came from the BoE’s Decision Maker Panel survey, which showed a widespread decline in inflationary pressure. But the BoE has made clear that it’s hard data that matters, and this week’s UK calendar will be quite helpful in that sense. Wage and jobs data will be the key release tomorrow. Private sector wage growth currently stands at 8.2% and looks likely to remain unchanged, but there’s an outside risk that we see this nudge slightly lower. The unemployment rate may also nudge a bit higher. All that may fail to invert the dovish trend on UK rate expectations ahead of next week’s Bank of England’s policy meeting, although the pricing has already dropped quite substantially (16bp priced in for September, 35bp to a peak). Our economics team still thinks the BoE will go ahead with a hike this month. Inflation figures are out one day before the meeting, so while more GBP weakness is possible around this week’s data releases, next week could see some recovery. EUR/GBP may be trading well above 0.8600 once we get to the BoE meeting.

GBP: ECB helped BoE expectations stay low Sterling followed the euro lower against a backdrop of broad-based dollar strengthening yesterday, and Cable has heavily tested the 1.2400 support in the past 24 hours. The dovish tilt by the ECB likely added fuel to the ongoing dovish re-pricing of Bank of England rate expectations, and markets now price in only 34bp to a peak, a 40bp correction over the past month.   EUR/GBP moved back below the 0.8600 level after the ECB dovish hike, and may stay under some mild pressure into the BoE, but looks more likely to struggle finding much direction in the near term. This morning, the BoE will release a 12-month-ahead inflation expectation survey, which came in at 3.5% last month, although it is not likely to move the market substantially. Both investors and policymakers will still get the chance to look at a CPI print (on Wednesday) before the BoE announcement (on Thursday), which has a good chance of tilting market pricing.

Yen falls after BoJ decision, US bond investors hopeful on Treasury's plan to spend 'less'  By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank   The Bank of Japan (BoJ) kept interest rates unchanged, redefined the 1% limit on the 10-year JGBP yield as a loose 'upper bound' and scrapped its promise to keep that level intact. Alas, the move was less aggressive than expected by the market and sent the yen tumbling. Japanese policymakers' insistence that they won't hesitate to take additional easing measures 'if needed' also spoiled sentiment. The USDJPY trades just above the 150 mark this morning after the BoJ decision, although the spike in the 10-year JGB yield to almost 1% should've pulled the pair lower – especially after the news that the US Treasury will be borrowing less money in the last three months of this year.  The US Treasury will borrow less; the Fed is expected to announce no change. Yet...  The US Treasury Department said yesterday that they are planning to borrow around $776 billion in the final quarter of the year. That's still a historically high borrowing, but it has the merit to be below the expectation of around $800bn and it's well below the $1 trillion that they borrowed in the July-to-September period, and which wreaked havoc in the US bond market, sending – especially the long-end of the US yield curve rallying.  Today, the Federal Reserve (Fed) starts its two-day policy meeting. Yes, the FOMC announcement on interest rates is often a big event for investors, but this time around, it won't be the only shining star of the week. First, because we know that there won't be any rate hikes this week. The probability of no change is priced as being almost 100% sure. The Fed members will still be raising their eyebrows given the strength of the recent economic data, the uptick in inflation and global uncertainty. But they won't necessarily be raising the rates. Therefore, what they will say they will do will matter more for the market pricing than what they will do. And the rate expectations will be played for the December and January meetings – which both hint at no rate hike either, by the way. That could change, but for now, no more rate hike is what investors are betting on.   So, in the absence of a surprise rate decision, or a surprise forward guidance about a rate decision, what will really, really matter this week for the US sovereign space and the faith of the US yields, is the US debt situation, and the Treasury Department's quarterly announcement on details regarding the size and the maturity of the bonds that they will issue to borrow that extra $776 bn this quarter.  The composition of the US Treasury's bond issuances will be crucial. Shifting toward shorter maturity debt could relieve the pressure on the US long-term papers but the problem with the short-term bills is that the US Treasury already sold plenty of them - they came close to their self-imposed limit of 20% last quarter- and that's why they decided to sell more longer maturity bonds since September. The latter shift towards longer-term maturity debt explained why the long-term yields took a lift since September. Therefore, it's not a given that the Treasury's issuance calendar will fully calm down the bond investors' nerves on Wednesday. 

EUR: Lagarde to speak today The dollar’s bounce sent EUR/USD back close to the 1.0660 mark, and we cannot exclude a bit more pressure as the impact of yesterday’s US bond sell-off might be felt across European markets today. The EUR-USD 2-year swap rate differential has rewidened after yesterday’s events and is now close to the 136bp pre-FOMC low. Today's focus will be on a speech by European Central Bank (ECB) President Christine Lagarde in London. A slow shift from trying to convince markets another hike is a possibility (like in the US, investors remain hard to persuade) to pushing back more directly against rate expectations may start to appear more clearly in ECB members’ remarks. The EUR OIS curve prices in a first cut between April and June. The impact on the EUR from ECB speakers has been, however, quite modest and we doubt that would change in a very short time. Elsewhere in Europe, the UK released third-quarter growth data this morning. GDP was a tad better than expected for the third quarter as a whole, coming in flat, but this was entirely due to a fall in imports. In reality, the domestic elements of GDP were negative, and strike activity earlier in the summer is a key factor. In the bigger picture, the UK economy hasn't really grown this year in level terms. Our base case is stagnation/modest growth, but a recession can't be ruled out. Ultimately, the BoE won't be paying these figures too much attention, with the focus instead on next week's services inflation and wage growth figures.

Bank of Canada retains its hawkish bias The BoC kept rates unchanged as expected, but had to recognise that rates are “clearly restraining spending” and that disinflation is happening at a faster pace. However, that was not enough to drop the threat of another hike if necessary. While this is generally good news for CAD, external factors (US data in particular) remain much more relevant.   Sticking to the tightening threat The Bank of Canada kept rates unchanged at 5.0% today, as widely expected. The policy statement noted that “higher interest rates are clearly restraining spending: consumption growth in the last two quarters was close to zero, and business investment has been volatile but essentially flat over the past year”. Incidentally, the BoC recognised the faster pace on the disinflation front, dropping the reference to “slow” progress on inflation. Those considerations would have likely led to a more dovish tone on the policy outlook as a consequence, but the BoC decided to reiterate the threat of more monetary policy tightening instead: “Governing Council is still concerned about risks to the outlook for inflation and remains prepared to raise the policy rate further if needed”. The concerns about the inflation outlook come not only from potential external shocks (e.g. energy prices), but also from a resiliently tight domestic labour market, as confirmed by last week’s strong jobs figures. We are still convinced that the BoC will not tighten policy further given the deterioration of the economic outlook and our expectations for a steady decline in Canadian’s inflation. However, there is a likely intent to fight the ongoing dovish repricing of rate expectations in Canada, and that means the BoC out-of-meeting commentary may be careful to send dovish messages to the market before the January meeting, when new economic projections will be released.   CAD still too reliant on US data From a market perspective, the reiteration of the hawkish bias by the Bank of Canada is positive news for CAD, although the acknowledgement of faster inflation decline and the strong impact of tight monetary conditions on the economy have offset the impact on the loonie, which is holding steady after the announcement. Despite the BoC’s reluctance to pivot to a more dovish stance, the loonie remains highly affected from a deterioration in US data, to which it has the highest correlation in G10. In the short term, the last bits of evidence of US activity resilience may support CAD – especially in the crosses – but we expect the worsening of US (as well as Canadian) growth sentiment next year to make CAD less appealing than other risk-sensitive currencies like the antipodeans and Scandies.

UK: Bank of England to offer push back against rising tide of rate cut expectations Financial markets are rapidly throwing in the towel on the “higher for longer” narrative that central banks have been pushing hard upon for months. Admittedly so far, that market repricing has been less aggressive for the Bank of England. But with three rate cuts now priced for 2024, the Bank of England is starting to sound the alarm. Governor Andrew Bailey said in recent days that he is pushing back “against assumptions that we're talking about cutting interest rates". Those comments followed a firming up of the Bank’s forward guidance back in November, where it said it expected rates to stay restrictive for “an extended period”. Expect that narrative to be reiterated on Thursday. A 6-3 vote in favour of no change in rates is our base case, and that matches the vote split from November. Could the Bank go further still and formally say that markets are overpricing 2024 easing in the statement? It hasn’t commented in this way since November 2022, in what was then a stressed market environment. We doubt they’ll do something similar this month. Policymakers may be uneasy about the recent repricing of UK rate expectations, but central banks globally have learned the hard way over the last couple of years that trying to predict and commit to future policy, with relative certainty, is a fool's game. The Bank will also be gratified that the data is at least starting to go in the right direction. Services inflation came in below the Bank’s most recent forecast. Markets may be right to assume that the BoE will be a little later to fire the starting gun on rate cuts than its European neighbours. But when the rate cuts start, we think the BoE’s easing cycle will ultimately prove more aggressive. We expect 100bp of rate cuts from August next year, and another 100bp in 2025.

FX Daily: Not too hot to handle Rate expectations were not moved by slightly hotter-than-expected US CPI, and support for the dollar has mostly come through the risk-sentiment channel. Range-bound trading may persist despite conditions for a stronger dollar. Inflation in the CEE region is falling; the NBR leaves rates unchanged.   USD: Markets still attached to March cut US CPI data came in a bit hotter than expected yesterday, with the core rate rising 0.3% MoM and slowing to 3.9% YoY versus 3.8% consensus. The upside surprise in headline inflation was bigger: an acceleration from 3.1% to 3.4% YoY versus the 3.2% consensus. The dollar jumped after the release, also thanks to weekly jobless claims printing lower than expected. Somewhat surprisingly, the US yield curve did not react by scaling back rate cut expectations, as a knee-jerk selloff in 2-year Treasuries was fully unwound within an hour of the CPI release. We've already discussed how we did not expect this inflation read to leave a long-lasting impact on markets, and it definitely appears that most of the fixed-income investor community is almost overlooking the release. The support to the dollar appears mostly tied to the negative response in equities, given the neutral impact on short-dated US yields. A March rate cut is still over 60% priced in, and we still see short-term vulnerability for risk assets from a hawkish repricing. The conditions for a higher dollar this month are surely there, but we have observed numerous indications that markets remain reluctant to make short-term USD bullish positions coexist with the longer-lasting view that US rates will take the dollar structurally lower by year-end. The chances of rangebound trading until we receive clearer messages by activity data and the Fed are high. Today, PPI figures for December will be released, adding information about lingering price pressures and potentially steering the market a bit more. On the Fed front, we’ll hear from hawk Neel Kashakari.

FX Daily: Waiting on central bankers to shake data-resistant markets Investors have cemented Fed easing expectations despite some hotter-than-expected US data. We suspect a market reluctant to price out rate cuts will need strong words from the Fed – perhaps Powell himself – to reconnect rate expectations with data. Meanwhile, USD may stay rangebound. This week, Lagarde will speak in Davos, and UK CPI should slow further.   USD: Rate expectations still disjointed from data The first half of January has shown a dislocation between rate expectations and data in the US. The two most important data points for the Federal Reserve, labour and CPI inflation figures, both came in hotter than expected. PPI was a bit softer than consensus on Friday, but that is not enough to justify markets’ reluctance to price out Fed easing. The Fed funds future curve prices in 21bp of cuts in March, and 168bp by year-end. Our view remains that the Fed won’t start cutting before May, and that the total easing package will be 150bp. Accordingly, the rally in short-term USD rates appears overdone, and weakness in the front part of the USD curve should support some recovery in the dollar. However, we suspect that the data may prove insufficient to trigger a USD rebound for now; the consensus view of a dollar decline later this year seems to be making investors keen to sell dollar rallies. Also, the Fed probably needs to send a clearer message that the latest data does not justify the kind of aggressively dovish view embedded in money market pricing. There are a few more Fed speakers lined up this week, but perhaps dollar bears will want to hear it from Fed Chief Jerome Powell, who is not scheduled to speak until the 31 January FOMC announcement. Incidentally, the US data calendar isn’t very busy this week. Retail sales and the University of Michigan inflation expectations will attract the most attention along with jobless claims - which came in well below expectations last week, reinforcing the narrative of a still-tight labour market. We think the dollar will be driven more by other events than data this week, barring major surprises. First, the results of the election in Taiwan have raised again the delicate question of Taipei-Beijing relationships, with tensions among the two seen as a major risk for Asian and global risk sentiment this year. The dollar might benefit from some outflows from exposed EM FX. The situation in the Gulf also looks rather volatile after the US and UK military operations last week, even though the impact on oil prices has been muted so far.   Domestically, we’ll monitor the market reaction to the business tax relief extension currently being discussed in the US Congress. The impact of fiscal support may turn out to be negative for risk sentiment – and positive for the dollar – as markets see a greater risk of sticky inflation and a lower chance of Fed rate cuts. We think the dollar is more at risk of a rebound than a further correction from these levels, although the chances of another rangebound trading week in FX (DXY still hovering in the 102/103 region) are high.

EUR: Lagarde may sound more hawkish in Davos The data inputs for EUR/USD will mostly come from Germany this week, with 2023 GDP figures today and the ZEW survey tomorrow along with final CPI numbers. We have often discussed how European Central Bank rate cut expectations appear way too aggressive (150bp by year-end), although the dovish members of the bank have failed to deliver a coordinated pushback. Despite ECB hawks' protests against dovish expectations having had little impact on the market, the WEF event in Davos this week – which sees many ECB speakers including President Christine Lagarde – should not be overlooked. Lagarde has a greater potential to influence markets given a clearly divided Governing Council, and we suspect that she will opt for a more hawkish tone compared to last week’s comments. There may be some help for the euro coming from Davos, although we should be wary. Fed expectations have been resistant to data and the same could hold true for the ECB as well. The minutes from the December policy meeting are also released this week. We still think it is premature for EUR/USD to trade sustainably above 1.10. Elsewhere, Sweden published inflation figures today. CPIF declined to 2.3% from 3.6% (consensus 2.2%), although the core measure excluding energy remained high, slowing from 5.4% to 5.3% versus a consensus of 5.2%. Despite this, it remains unlikely that the Riksbank will tighten policy again. If anything, this modestly raises the chances that another round of FX sales will be started after the current reserve hedging programme ends in early February (in our view).

GBP: Services inflation to stay above 6% The data flow picks up this week in the UK, with labour (Tuesday), CPI (Wednesday) and retail sales (Friday) statistics for the month of December being released. Services inflation is what matters the most for the Bank of England at the current stage and we expect to see it at 6.1% this week, considerably below the Bank of England's estimates. Despite the improvement in services disinflation, 6%+ remains too high and is unlikely to make the BoE endorse dovish rate expectations just yet. EUR/GBP can retest the 0.8573 lows, but we expect it to find a bit more support this week as the euro may benefit from some hawkish comments by Lagarde in Davos. Our medium-term view on the pair remains bullish.

The Canadian dollar has continued to edge lower against its US counterpart since the start of the year, with the USD/CAD pair beginning the week around the 1.34 level, which is around its highest level since the middle of December. We are entering into a highly important couple of weeks for the Canadian dollar. Tuesday’s inflation report will be a highly important one in guiding Bank of Canada interest rate expectations. Economists are pencilling in a monthly contraction in headline consumer prices (-0.3% consensus), which would be only the second negative print in the past year. Retail sales data on Friday should also give policymakers a decent barometer as to how well consumer spending held up towards the end of last year, as we head into the January BoC meeting next Wednesday. No change in rates is seen, although the tone of the bank’s communications will held investors gauge whether we can expect a first cut as early as April, which is currently more than fully priced in by swaps.

UK inflation unexpectedly rises By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank   Yesterday was just another day where another policymaker pushed back on the exaggerated rate cut expectations. Federal Reserve's (Fed) Christopher Waller said that the Fed should go 'methodically and carefully' to hit the 2% inflation target, which according to him is 'within striking distance', but 'with economic activity and labour markets in good shape' he sees 'no reason to move as quicky or cut as rapidly as in the past', and as is suggested by the market pricing. So that was it. Another enlightening moment went down the market's throat in the form of a selloff in both equities and bonds. The US 2-year yield – which captures the rate expectations rebounded 12bp, the 10-year yield jumped past the 4%, the US dollar index recovered to a month high and is testing the 200-DMA resistance to the upside this morning, while the S&P500 retreated 0.37%.   Waller spoke from the US yesterday, but many counterparts are wining, dining and speaking in the World Economic Forum in Davos this week, which doesn't only offer snowy and a beautiful scenery this January, but it also serves as a platform to many policymakers to bring the market back to reason. Expect more comments of this hawkish kind during this week. It turns out that one of the most popular topics of this year's WEF is rising inflationary risks due to the heating tensions in the Red Sea which disrupt the global trade roads and explode the shipping costs.  

Bank of Canada preview: Too early for a radical pivot Core inflation came in hotter than expected in December which rules out the Bank of Canada shifting meaningfully in a dovish direction at the January meeting. However, higher interest rates are biting and we continue to look for rate cuts from the second quarter onwards. US-dependent BoC rate expectations and the Canadian dollar may not move much for now.   Hot inflation warrants caution before dovish turn The Bank of Canada is widely expected to leave the target for the overnight rate at 5% when it meets next week. Policymakers continue to talk of their willingness to “raise the policy rate further if needed”, and inflation does indeed continue to run hotter than the BoC would like, but we see little prospect of any additional policy tightening from here. Instead, the next move is expected to be an interest rate cut, most probably at the April meeting. The latest BoC Business Outlook Survey reported softening demand and “less favourable business conditions” in the fourth quarter with high interest rates having “negatively impacted a majority of firms”, leading to “most firms” not planning to “add new staff”. Job growth does appear to be cooling and the Canadian economy contracted in the third quarter and is expected to post sub 1% growth for the fourth quarter. Also remember that Canadian mortgage rates will continue to ratchet higher for an increasing number of borrowers as their mortgage rates reset after their fixed period ends. This will intensify the financial pressure on households, dampening both consumer spending and inflationary pressures. Unemployment is also expected to rise given the slowdown in job creation and high immigration and population growth rates. Given this backdrop, we expect Canadian headline inflation to slow to 2.7% in the first quarter and get down to 2% in the second versus the consensus forecast of 2.6%. As such, we see scope for the BoC to cut rates by 25bp at every meeting from April onwards – 150bp of interest rate cuts versus the consensus prediction and market pricing of 100bp of policy easing.   Rate expectations in US and Canada   Fighting market doves is still hard Markets currently price in 95/100bp of easing by the Bank of Canada this year. As shown in the chart above, the pricing for rate cuts in the US and Canada has followed a very similar path. The implied timing for the first rate cut is also comparable: May for the Fed (March is 50% priced in), June for the BoC (April is 45% priced in). That is despite the communication by the Federal Reserve which has already pivoted (via Dot Plots) to the easing discussion while the BoC officially still retains a tightening bias. In practice, even if the BoC chooses – as we suspect – to delay a radical dovish pivot and stay a bit more hawkish than the Fed, pricing for the BoC will not diverge too much from that of the Fed. So, the room for a rebound in CAD short-term rates appears more tied to USD rates than BoC communication.     FX: USD/CAD to stabilise In FX, the story isn’t much different. The Canadian dollar has been a de-facto proxy for US-related sentiment, acting less and less as a traditional commodity currency – that would normally be hit by strong US data – thus outperforming the rest of high-beta G10 FX since the start of the year. The rebound in USD/CAD to 1.35 is in line with a restrengthening of the USD primarily due to risk sentiment, positioning and seasonal factors, rather than a divergence in Fed-BoC policy patterns. In fact, the USD-CAD two-year swap rate gap has widened further in favour of CAD so far in January, from 20bp to 32bp.   We expect the impact on CAD from this BoC policy meeting to be modestly positive as expectations of a radical dovish shift are scaled back. However, Governor Tiff Macklem already introduced the idea of rate cuts in a speech this month and will need to acknowledge the downward path for the policy rate to a certain extent. While waiting for the Fed meeting a week later and the crucial US CPI numbers for January, US-dependent rate expectations in Canada may not move much. USD/CAD may trace back to 1.34, but we don’t see much further downside for the pair this quarter as USD shows the last bits of strength.