Overnight, Fed Governor Lael Brainard added another touch to the positive picture painted by other Fed policymakers on Tuesday, who hinted that a March rate hike may be on the way. In her speech, Brainard said that a rate hike will likely be appropriate soon given improved global conditions and continued growth. She noted that "constraints" of the past two years, caused by problems from Europe to China are easing. With regards to the domestic economy, she noted that the Fed’s employment and inflation goals are nearly met, allowing a continued gradual pace of rate increases. Given that Brainard is a Governor, which implies a permanent vote within the Committee, her comments were taken seriously by the market, which is now pricing in a much higher probability for a March hike than yesterday. According to our model which is based on the yields of the Fed funds futures, that probability has risen to 50% from 36%. Despite the recent fuss around the next hike in the Fed funds rate, and the continued increase of the probability for that to happen in March, we still believe that the recent sentiment around that prospect is more optimistic than it should be. We stick to our call that June is a more likely candidate. Despite getting positive vibes from key voting members, we still believe that the overall voting squad within the Committee has turned more dovish this year. After all, this was evident by the latest FOMC meeting minutes. What’s more, yesterday’s release of the core PCE index, which is the Fed’s favorite inflation measure, showed that the rate remained unchanged instead of rising as many had expected. The spotlight now turns to Fed Chair Yellen and Vice Chair Fisher, who are both scheduled to speak on Friday. In order to reevaluate our view, we need to see the two leading Fed officials unleashing equally hawkish signals to those of their colleagues, as well as a strong employment report next week, especially as far as the earnings are concerned.
EUR/USD traded lower during the European morning yesterday, but rebounded later in the afternoon to hit the resistance of 1.0570 (R1). Subsequently, it came back under renewed selling interest and continued lower after Brainard’s remarks. Now the pair looks to be headed for another test near the 1.0500 (S1) territory, where we expect investors to settle and wait for Yellen’s and Fisher’s speeches. If the two top Fed officials share the view that a near-term rate hike has become increasingly likely, then we may see a dip below the aforementioned key support obstacle, something that could open the way for our next support of 1.0450 (S2). With regards to the bigger picture, we still see a longer-term downtrend. Positive vibes from more FOMC members and a potential strong US employment report next week combined with the political uncertainty surrounding the Euro-area could encourage the bears to stay in the driver’s seat. This could eventually lead to another test near the 1.0360 territory, defined by the lows of December and January.
BoC remains on hold amid "significant uncertainties"
The Bank of Canada kept its policy unchanged yesterday, as was widely anticipated. The statement accompanying the decision was upbeat on some aspects of the domestic economy. However, it also warned that exports continue to face competitiveness challenges. With regards to the Loonie, the Bank said that both CAD and bond yields have remained at levels similar to the latest meeting, implying that they are still undesirably high. All these echo comments from the previous policy meeting that the strength of the Canadian dollar is muting the outlook for exports. The Bank ended the statement by noting it will remain attentive to the impact of significant uncertainties weighing on the outlook, and that it will continue to monitor the risks. Given the somewhat worried tone, the reaction in the Loonie was negative.
USD/CAD surged after it hit support near the 1.3300 (S2) territory, to break above the resistance (now turned into support) level of 1.3340 (S1) and the longer-term uptrend line taken from the lows of May 2016. Given the recent optimistic signals from the Fed with regards to the next hike, as well as this cautious tone from the BoC, we believe that the pair could continue higher in the days to come. A clear break above 1.3390 (R1) could pave the way for the 1.3460 (R2) area. As for the broader trend in USD/CAD, as long as the pair remains within the sideways range that has contained the price action since September 2016, between 1.3000 and 1.3600, we consider the overall outlook to be neutral. A clear break above 1.3600 is needed to turn the broader path to the upside as well.
Back to the BoC, we believe that a large part of the uncertainty the Bank sees weighing on the domestic outlook relates to the appreciation of the Canadian dollar late last year. Although we do not expect this appreciation to actually lead to a rate cut, we believe that it could keep the tone of the BoC somewhat dovish in the foreseeable future, as they prefer to keep CAD from strengthening too much.
Today’s highlights:
During the European day, we get Eurozone’s preliminary CPI data for February. The forecast is for the headline rate to have risen further, while the core rate is expected to have remained unchanged for the third consecutive month. ECB President Draghi placed a lot of emphasis on Eurozone’s core CPI at the latest policy gathering. He said that although the headline rate has risen recently, that reflects primarily transitory effects. He made it clear that until there are convincing signs of an upward trend in core inflation, the Bank is likely to keep its policy stance unchanged. Therefore, we believe that even though further upturn in the headline CPI rate could support the euro somewhat, if the core rate remains unchanged as expected, any positive reaction in the currency is likely to be only modest. We also get the bloc’s unemployment rate and the PPI, both for January.
From the UK, we get the construction PMI for February and expectations are for the index to have held steady from the previous month. We see the risks surrounding that forecast as skewed to the downside, considering the somewhat disappointing manufacturing print for the month. In case of a decline, GBP could come under renewed selling interest.
In the US, initial jobless claims for the week ended February 24th are due out.
From Canada, we get GDP data for Q4. In the absence of a forecast, we see the case for GDP growth to have accelerated from the previous quarter, in line with the BoC view at yesterday’s meeting. Accelerating GDP growth could cause the CAD to recover some of its losses from yesterday, but bearing the Bank’s discontent with regards to a strong domestic currency, we expect such a reaction to remain short-lived.
We have only one speaker scheduled for today: Fed Board Governor Jerome Powell. Considering that he is also a permanent voting member, investors are likely to scan his speech for any additional signals on a March hike.
