Sample Category Title

Part IV: Conclusions

Summary

• Monetary systems have evolved over centuries, and there is nothing inherently "permanent" about the current system, which is composed of "public" money (i.e., paper bills that are the liabilities of central banks) and "private" money (i.e., bank deposits that are the liabilities of private enterprises).
• In our view, cryptocurrencies with high price volatility and inelastic supplies (e.g., Bitcoin and Ether) likely will continue to represent an important investment class, but they are ill-suited as a form of money.
• Likewise, privately-issued stablecoins, at least as currently constructed, are also ill-suited as a form of money due to their potential susceptibility to "runs."
• Many major central banks are actively weighing the benefits and drawbacks of issuing their own central bank digital currencies (CBDCs). The Federal Reserve has essentially handed the decision about potential issuance of a U.S. CBDC to lawmakers.
• Determining exactly what Congress will eventually authorize, if indeed it actually does, is more or less impossible. But a scenario in which Congress chooses not to authorize a U.S. CBDC does not seem implausible to us. We could envision a scenario in which lawmakers require that private stablecoin issuers become insured and regulated depository institutions. Under such a scenario, the line between stablecoin issuers and commercial banks would become increasingly blurred.
• Due to the benefits of digitization, it is only a matter of time before some form of digital currency takes its place among the primary methods through which payments are made, in our view.

NOT A DEPOSIT. NOT PROTECTED BY SIPC. NOT FDIC INSURED. NOT GUARANTEED. MAY LOSE VALUE. NOT INSURED BY ANY FEDERAL GOVERNMENTAL AGENCY

This commentary is provided for information purposes only and does not contain any recommendations or investment advice. The Firm makes no recommendation as to the suitability of investing in digital assets, including cryptocurrencies. Investments in digital assets carry significant risks, including the possible loss of the principal amount invested. It is only for individuals with a high risk tolerance who can withstand the volatility of the digital asset market. Investors should obtain advice from their own tax, financial, legal and other advisors, and only make investment decisions on the basis of the investor's own objectives, experience and resources.

The Form of Money Continues to Evolve

We began this four-part series on digital currencies by describing in Part I how exchange has evolved over the centuries. Initially, exchange took place by barter, but humans eventually invented "money," because it is a more efficient form of exchange than barter. Forms of money with intrinsic value, such as cowrie shells and precious metals, eventually gave way to paper money. Today, the monetary system of most economies is composed of risk-free "public" money (i.e., paper bills that are the liabilities of central banks) and "private" money (i.e., bank deposits that are the liabilities of private enterprises).

Individuals and businesses in most economies willingly accept private money as a perfect substitute for risk-free public money, because the value of bank deposits is guaranteed, at least up to some limit. Furthermore, the supervisory and regulatory framework that exists in most economies gives the public some confidence that the banking system is financially sound. In short, money today is "backed" by trust. Individuals accept paper bills and checks as means of payment for goods and services, because they trust that other people will in turn accept those forms of money as payment. If that trust breaks down, then so too does the monetary system.

Pros and Cons of Digital Currencies as a Form of Money

There are no features of the current monetary system that necessarily make it the final stop in the evolution of money. In that regard, cryptocurrencies, which exist in electronic form only, have come into use as a medium of exchange in recent years. Moreover, the explosive growth in digital currencies, which did not even exist prior to 2009, is a testament to some of their qualities that make them a better medium of exchange than paper money.1 Among other benefits, which we discussed in more detail in Part I, is the speed of payment. Rather than waiting for the "check to clear," settlement in digital currencies occurs essentially instantaneously.

But one of the most notable drawbacks to some cryptocurrencies is their extreme price volatility. For example, the price of Bitcoin has dropped roughly 35% on balance since its peak in November, and daily changes of 10% are not uncommon (Figure 1). This volatility derives from the limited supply of many cryptocurrencies. Prices can fluctuate widely as demand shifts back and forth along an inelastic supply curve. Due to this high degree of price volatility, many cryptocurrencies are not good "stores of value," at least not over short periods of time. Furthermore, the limited supply of these digital currencies could potentially lead to price deflation of goods and services.

There is a class of digital currencies, known as "stablecoins," which we discussed in more detail in Part II that tend to have stable values. Therefore, stablecoins would be a better form of money than cryptocurrencies that have higher degrees of price volatility. In addition, the supply of stablecoins can expand elastically as demand increases. The potential deflationary situation that is associated with inelastically supplied cryptocurrencies does not arise with stablecoins.

However, the major drawback to privately-issued stablecoins is their potential susceptibility to "runs." Stablecoin issuers hold assets that they can use to meet redemptions. In addition to bank deposits and risk-free Treasury bills, the assets of stablecoin issuers often include higher-yielding commercial paper. The values of stablecoins are generally stable. But because stablecoins are the liabilities of private enterprises that are not guaranteed, their prices can decline when owners of the tokens start to question the value of the issuer's assets. For example, the price of Tether, one of the most highly traded stablecoins, weakened noticeably in March 2020 when financial market volatility spiked (Figure 2). In short, privately-issued stablecoins can be subjected to runs, much like commercial banks were prior to the establishment of deposit insurance and credible supervisory and regulatory agencies. If runs on stablecoin issuers were to become systemic, then financial stress could potentially become extreme. In other words, trust, which is the only quality that "backs" money today, could break down.

As noted earlier, currency is a risk-free asset for the public, because it is a liability of the central bank. But there are some drawbacks to currency, which we discussed in more detail in Part III. Specifically, currency is not an efficient way to make large value payments or payments that need to be made remotely. These problems could be solved if central banks could create their own digital currencies. These so-called central bank digital currencies (CBDCs) could also offer some benefits in the form of monetary policy options. But there are many complex design issues involved with CBDCs that require careful consideration. For example, CBDCs would be risk-free assets of individuals and businesses that hold them. If the public perceives CBDCs to be superior to the liabilities of commercial banks, then disintermediation from the banking system could occur, which potentially could have negative consequences for economic growth.

Therefore, many central banks are proceeding cautiously with the introduction of digital currencies. Among major central banks, only the People's Bank of China has issued a CBDC to date. The Swedish Riksbank has tested a prototype and the European Central Bank plans to have its own prototype ready for testing in 2023, although neither central bank has yet to commit to actual issuance. The Federal Reserve is conducting in-depth research about the pros and cons of its own digital currency, but it has essentially handed the decision about potential issuance of a U.S. CBDC to lawmakers.

What Does the Future Hold for Digital Currencies?

So, what does the future hold? For starters, digital currencies have established a firm foothold in the global financial system, and they are simply not going away, in our view. But we believe that cryptocurrencies with inelastic supplies and significant price volatility (e.g., Bitcoin and Ether) will play a limited role as a form of money. Money has three functions: it is a medium of exchange, a unit of account and a store of value. Digital currencies such as Bitcoin and Ether are currently being used as a medium of exchange, but only to a limited extent. Rather, the vast majority of transactions today continue to be made in national currencies (e.g., U.S. dollars, euros, etc.) Their use as a unit of account is also quite limited at present. That is, prices of most goods and services continue to be denominated in national currencies, not in terms of specific cryptocurrencies.

Prices of many cryptocurrencies with inelastic supplies have risen significantly on balance since their introduction, but their price volatility does not make them good stores of value, at least not over short-run horizons. Consequently, most individuals and corporate treasurers likely would not want to make this class of cryptocurrencies a significant part of their liquid cash balances. To the best of our knowledge, there has been no issuance to date of securities (i.e., stocks and bonds) that are denominated in inelastically supplied cryptocurrencies. Securities continue to be denominated in national currencies such as U.S. dollars, euros, Japanese yen, etc. As long as prices of these inelastically supplied cryptocurrencies remain highly volatile, we think that corporate treasurers will largely refrain from issuing securities that are denominated in them. Therefore, individuals who want to invest in this class of cryptocurrencies are largely limited to owning just the digital currency, rather than an interest-earning or dividend-paying security.

In our view, cryptocurrencies with inelastic supplies and highly volatile prices will continue to offer investment opportunities for individuals and institutions, especially those with high tolerances for risk. In that regard, this class of cryptocurrencies likely will represent an important investment class, similar to emerging market securities. Although these cryptocurrencies are not currently regulated, they potentially could fall under the regulatory purview of an agency such as the Securities and Exchange Commission (SEC). We will defer to investment professionals regarding issues of investment options and potential regulation. But we do not see cryptocurrencies with inelastic supplies and high price volatility replacing national currencies as the primary mediums of exchange and units of account anytime soon.

The class of digital currencies that are known as stablecoins have some advantages over their more volatile counterparts in terms of a form of money. In addition to the property of instantaneous payment, a quality that is inherent of all digital currencies, stablecoins generally have stable values and elastic supplies. But as noted previously, the main drawback to stablecoins is that they are liabilities of private enterprises that are not guaranteed, at least not at the present time. Their potential susceptibility to runs could add to volatility during periods of financial stress.

Furthermore, there is the issue of "convertibility" among stablecoins. Assume that Individual A, who has a Tether account, needs to pay Individual B, who has an account that is denominated in USD Coin. One of the individuals could exchange one stablecoin for the other, but there would be transaction costs associated with the exchange. These transaction costs do not arise when individuals are making and receiving payments in the same national currency (e.g., U.S. dollars). Because of their potential susceptibility to runs and this convertibility issue, we do not envision the replacement of national currencies with privately-issued stablecoins, as currently constructed, anytime soon.

Central banks could potentially begin to issue their national currency by digital means rather than via paper bills. Large and remote payments, which are problematic for paper currencies, could be made easily with CBDCs. But a notable drawback to CBDCs is that they could lead to disintermediation from the commercial banking system, if ill-designed. Furthermore, most central banks simply do not have the scale or the scope to onboard and maintain the accounts of millions of households and businesses, a task that currently is being handled by commercial banks in each individual economy. Many major central banks are actively considering the pros and cons of digital currencies, but none to date, aside from the Peoples Bank of China, have begun to issue their own CBDC.

Due to the benefits of digitization, it is only a matter of time before some form of digital currency takes its place among the primary methods through which payments are made, in our view. But we also believe that there will be some public element to payment-related digital currencies due to the drawbacks of privately-issued stablecoins that were noted previously. The exact design of these digital currencies will ultimately depend on the legal, regulatory and political milieus of each economy that adopts one. In the United States, the Federal Reserve has highlighted four basic principles to which any U.S. CBDC would need to adhere: privacy protection, intermediated (i.e., offered via the private sector), transferable and identity-verified. However, the Federal Reserve has also said that "it does not intend to proceed with issuance of a CBDC without clear support from the executive branch and from Congress, ideally in the form of specific authorizing law."

Determining exactly what Congress will eventually authorize, if indeed it actually does, is essentially impossible. But a scenario in which Congress chooses not to authorize a U.S. CBDC does not seem implausible to us. There already is some skepticism in Congress regarding CBDCs. For example, Representative Tom Emmer (R-MN) recently introduced a bill that would amend the Federal Reserve Act to prohibit the Fed from issuing "a central bank digital currency directly to an individual." Of course, Emmer is just one voice in Congress, but the political economy of the country seems to skew toward private sector solutions to many issues, including those that are related to the financial sector.

So, if Congress does not authorize a U.S. CBDC, how could it allow the country to capture the benefits of payment digitization? The report that was published in November 2021 by the President's Working Group on Financial Markets (PWG) offers a potential way forward. As we noted in Part II, the PWG report concluded that Congress should pass legislation requiring stablecoin issuers to become "insured depository institutions, which are subject to appropriate supervision and regulation." Deposit insurance in conjunction with a robust supervisory and regulatory framework should largely prevent "runs" on stablecoin issuers, much as bank runs have become exceedingly rare since the creation of the Federal Deposit Insurance Corporation (FDIC) in 1933.

If Congress were to follow the PWG recommendation, then stablecoin issuers would start to resemble commercial banks, which currently issue private money in the form of bank deposits. Legislation could be crafted such that these stablecoin enterprises would need to hold some proportion of their privately-owned deposits as reserves at the Federal Reserve, much as commercial banks do today. Commercial banks in turn could also begin to issue their own digital forms of private money, with the blessing of the regulatory authorities. Over time, the lines between stablecoin issuers and commercial banks would become increasingly blurred. The government would continue to delegate the task of issuing most of the nation's money supply to the private sector, with appropriate regulatory and supervisory oversight, including robust capital requirements. The private sector would be able to drive innovation in payment technologies, as it does today.

Under this scenario, the potential for disintermediation of the banking system would largely disappear, because the United States would not have a CBDC. Likewise, the potential of runs on stablecoin issuers would also become largely irrelevant, because they would be insured and regulated enterprises. But what about the issue of "convertibility"? Similar to the current environment, in which numerous stablecoins exist, a specific bank/stablecoin issuer presumably would be issuing its own form of digital currency, while another platform would be issuing a different form of digital currency. Would these two currencies be easily and inexpensively convertible?

The Federal Reserve noted in its report that "transferability" is one of the qualities a CBDC should have. That is, a CBDC "would need to be readily transferable between customers of different intermediaries." Although this quality is meant to apply to any digital currency that the Fed would issue, it could equally apply to digital currencies that are issued via the banking system. Any legislation that requires stablecoin issuers to become insured depository institutions could also include the requirement that their tokens are readily transferable between different depository institutions.

But even if legislation did not specify this requirement, we think competitive pressures would eventually force the stablecoins of different private sector issuers to largely resemble each other. U.S. dollars that are held in one commercial bank today are identical to U.S. dollars held in another commercial bank. Moreover, an individual can send payments of U.S. dollars to another individual without transaction costs. So, we think depository institutions/stablecoin issuers would all eventually issue the same U.S. dollar-based digital currency.

Conclusion

Starting with Bitcoin's inception in 2009 to today, the number of digital currencies in circulation has exploded from one to more than 17,500, which have an aggregate value of roughly $2 trillion at present. Although the exact future of digital currencies is difficult to discern, one thing seems certain to us: they are here to stay. There is nothing inherently "permanent" about the current form of money, and digital currencies have many superior qualities to paper money.

But there are different types of digital currencies, and some are better suited for some purposes than others. There is a class of digital currencies that generally have inelastic supplies with high degrees of price volatility. Notable examples are Bitcoin and Ether. In our view, digital currencies with these characteristics are ill-suited to serve as a form of money, and we do not envision them replacing national currencies as the primary mediums of exchange and units of account anytime soon. But they could represent a class of investment assets that, although unregulated at present, may eventually fall under some regulatory purview. But we will defer to the opinions of investment professional on these matters.

There is another class of digital currencies, which are known as stablecoins, that tend to have stable values and elastic supplies. But they are the liabilities of private enterprises and their values are not insured, which makes them potentially susceptible to runs. Therefore, we do not envision them replacing national currencies, at least not as they are currently constructed. That said, stablecoins have more promise than inelastically supplied digital currencies as potential forms of money, if some changes are implemented.

Much will depend on the decisions that governments make regarding CBDCs. If a government decides to move ahead with a CBDC, then the future of privately-issued stablecoins would likely be more tenuous. Everything else equal, why would the public want to use the liabilities of a private enterprise as a form of money when it could use a risk-free digital currency that is supplied by the central bank? But stablecoins could still have a future depending on the underlying design features of the CBDC. Outside of China, actual issuance of CBDCs, if it occurs at all, still seems to be a few years in the future in most economies.

Will the United States ever have a CBDC? It obviously is difficult to know with certainty, but we are skeptical. The Federal Reserve does not intend to move forward with issuance "without clear support from the executive branch and from Congress." In our view, the political economy of the United States skews toward private sector solutions to many issues, and a CBDC could potentially threaten many private enterprises in the financial system. We can envision a solution whereby Congress passes legislation that requires stablecoin issuers to become insured depository institutions with appropriate regulatory and supervisory oversight.

Under such a scenario, the line between stablecoin issuers and commercial banks would become increasingly blurred. But the advantage of such a scenario is that the private sector would continue to drive innovation in payment technologies. Moreover, this scenario would be more or less similar in design, and therefore familiar, to the current banking system. That is, the majority of the nation's money supply is "private" money that is supplied by private enterprises. The only difference between the current system and the system of the future would be the form of money. Money at present is paper in form; it would be digital in the future.

Endnote

1 When we published our first report on January 10, there were about 16,400 digital currencies at that time. The number of digital currencies today exceeds 17,500. (Return)

Traders are betting the Fed will take a sledgehammer to crush inflation, but that wasn’t enough to really boost the dollar until fears of armed conflict in Ukraine sent investors into the reserve currency’s safety. The latest retail sales data will hit the markets on Wednesday alongside the minutes of the most recent Fed meeting, and how the dollar reacts could reveal whether the rally is truly exhausted. 

Lackluster dollar

With US inflation continuing to accelerate, markets are betting the Fed will be forced to respond with aggressive rate increases. Six and a half rate increases have now been priced in for this year and speculation about a 50 basis points move at the next meeting in March is running wild.

The worrisome part is that the dollar couldn’t properly capitalize on all this. This has been a consistent pattern in recent weeks, with strong US data releases sparking huge moves in bond markets but unable to boost the dollar much.

Take last week’s inflation numbers. One extra rate hike was priced into bonds in a matter of hours, yet the dollar barely rose. It did rally eventually, but most of that came down to safe-haven flows after headlines that an invasion of Ukraine may be imminent.

When a currency cannot rally on good news, that’s usually a sign of exhaustion in the trend.

Big test coming up

We’ll get a clearer sense of whether that’s true this week. The minutes of the latest Fed meeting will be released at 19:00 GMT on Wednesday. Traders will look for details around the quantitative tightening process and how the various officials feel about a 50 basis points move in March to kick off the tightening cycle.

Markets usually react to this release, but this time, the minutes will likely be outdated. This meeting took place before the latest jobs report, where wage growth fired up, and before the latest inflation stats that also exceeded expectations. This means that the argument for tightening policy quickly has become stronger since then.

Instead, the spotlight could fall on retail sales, which will be released a few hours earlier at 13:30 GMT. Forecasts point to a powerful rebound of 2% in January, following a drop of 1.9% the previous month. However, the retail control group that is used in GDP calculations is expected to have risen by only 1% after falling 3.1% in December.

If retail sales exceed expectations and the dollar cannot rally powerfully in response, that would be another sign that the uptrend is running on fumes.

Taking a technical look at euro/dollar, a potential decline could encounter immediate support near the 1.1280 zone, where a violation would turn the focus towards 1.1230.

On the other hand, in case of a disappointment the pair could edge higher. A clear break above the 1.1370 region could open the door towards 1.1485.

One last push? 

Overall, the dollar can be broken down into a short-term and longer-term outlook. In the near term, there might be another push by the bulls. Markets can still price in a seventh rate hike for the year, while geopolitical worries and the volatile environment in stock markets could continue to drive safe-haven flows into the reserve currency.

In the longer term though, the picture seems to be turning. Inflation might peak over the coming months and once that happens, traders could dial back bets for aggressive Fed rate increases. That could have a tremendous FX impact because the Fed is no longer the only game in town - other major central banks including the European one are also moving towards higher rates.

In short, it’s just difficult to see a ton of upside here with the Fed already priced so aggressively, although any trend reversal might be a story for the second half of the year.

Canada will be next to report its January CPI inflation readings on Wednesday at 13:30 GMT. Forecasts point to some stabilization but given the upside surprise in other major economies, Canada may not be an exception. Investors are certain the central bank will take its tightening phase to the next level of rate hikes in the coming months, though how aggressively it could respond is still unknown and the new inflation update may add new information to the puzzle, likely helping the loonie to steal some ground against its US cousin. Retail sales will be the next highlight on Friday at the same time.

Not a rate hike but multiple rate hikes

The Bank of Canada surprisingly held its benchmark interest rate stable during its January meeting in the face of omicron infections but removed its commitment to hold borrowing costs at the effective lower boundary following the termination of its bond program in October and the switch to the reinvestment phase. Traders are now blindly convinced that the central bank will deliver 25-bps rate hikes at each of its six meetings to drive rates up to 1.75% by October 2022. Besides, BoC governor Tiff Macklem came to confirm last week that “the rising path in rates is not one increase, it’s multiple increases”.

Can CPI data break the loonie's range-bound trading?

With investors already set up for the tightening phase, the question now comes down to Wednesday’s CPI inflation readings and how they could affect market expectations and therefore the Canadian dollar, which has been trapped within the 1.2800 – 1.2665 region so far this month despite the spike in oil prices.

Expectations are for the headline CPI rate to keep a steady pace at the three-decade high of 4.8% year-on-year, while the monthly figure is projected to return to growth, rising by 0.6% after contracting by 0.1% in the preceding month. If the data match forecasts, the loonie could barely react even if the rate hike scenario still remains on the table. On the other hand, an upside surprise similar to what the US and the Eurozone have experienced could bode well for the currency if traders start to bake in more aggressive rate hike increases as in the case of the Fed.

Of course, unlike January’s US jobs data, the Canadian employment report was a disappointment, showing a job loss of 200k and a higher unemployment rate at 6.5%. Friday’s retail sales data for December could be bleak as well, showing the largest decline since July 2021. Yet the Canadian economy and particularly the labor market has proved that any slowdown following previous pandemic waves was only a bump in the road with some inflationary consequences.

USD/CAD

Therefore, traders may not easily dash their rate hike expectations, but they will probably wait to see whether the upcoming CPI inflation figures can support steeper rate increases before they drive dollar/loonie below the 1.2700 level and towards the range’s lower boundary of 1.2665. If the latter fails to hold, the next stop could be around 1.2630, where any violation is expected to trigger a sharper decline towards the 1.2500 handle.

In the event the data come in below expectations, the pair could face little volatility. Nevertheless, traders would keep a close eye for any bullish breakouts above the 1.2800 - 1.2830 resistance band.

WTI oil price pulls back from new 7-year high on Tuesday, as geopolitical tensions ease on news that Russia returns some military units to their bases after exercises near Ukrainian border.

Optimistic news prompt traders to collect some profits from strong bullish acceleration in past two days after the situation became overheated on signals from the western media that Russia could attack Ukraine these days.

The oil price eased over 3% since opening on Tuesday, with possibility for a deeper drop if the situation in Ukraine cools down further that would ease concerns over strong supply disruption, expected on escalation of conflict.

Revived nuclear talks between Iran and the United States also boost optimism. If two countries reach an agreement that would allow for higher Iranian oil exports and increase pressure on oil prices.

The geopoliticals are expected to remain key driver of oil prices, with easing in tensions to push the price significantly lower.

Technical studies on daily chart started to weaken and develop an initial negative signal, with today’s strong bearish close to complete reversal pattern and weaken near-term structure.

South-heading 14- momentum indicator and RSI reversal from overbought territory, add to negative signals, which wood look for confirmation on break below psychological $90 support.

Fresh bears pressure rising 10DMA ($91.14), which guards $90 support and other pivotal levels at $88.64 and $87.91 (ascending 20DMA/Fibo 23.6% of $62.42/$95.79 rally). Break of these supports would signal deeper pullback and expose key Fibo support at $83.04 (Fibo 38.2% of $62.42/$95.79 rally).

Res: 91.96; 93.14; 95.14; 95.79.
Sup: 91.14; 90.00; 88.64; 87.91.

US producer prices rose 1% in January, double analysts’ forecasts. The annual growth rate slowed from 9.8% to 9.7% for the first time after nearly two years of gains, but analysts had been bracing for a sharper decline, expecting to see a slowdown to 9.1%. The core producer price index (excluding food and energy) slowed from 8.5% to 8.3%, against an expected 7.9%.

This is a new batch of bullish news for the dollar. The continued high rate of price growth continues to feed the ultimate inflationary spiral, demanding a more hawkish response from the Fed. The CME FedWatch Tool shows that markets are laying down a 62% chance of a 50-point rate hike in mid-March, a much higher rate than we can see from other G7 central banks, which makes Treasury short-term bills more profitable and feeds interest in dollar purchases.

Potentially, only the Bank of England was close to a radical move as a 50-point hike last month. But the markets are now expecting a 25-point rate hike from the Bank of England at the next meeting and do not expect any hikes from other central banks in the coming months. It is not surprising to see an interest in the USD and DXY growth in this environment.

WTI crude oil tumbles sharply today on de-escalation in Russia-Ukraine situation. Technically, a short term top should be in place at 95.98. Immediate focus is now on 55 day EMA (now at 91.18). Sustained trading below this level will argue that WTI is already in correction to whole rally from 66.46. In this case, deeper correction would be seen through 88.66 support to 38.2% retracement of 66.46 to 95.98 at 84.70, which is inside 82.42/87.70 support zone, and then be close to 55 day EMA.

Gold of also retreated sharply from 1879.24, after failing to sustain above 1877.05 resistance. The development dampened the immediate bullish case, and some consolidations could be seen first. But further rally will remain in favor as long as 1820.72 support holds. Break of 1879.24 will resume the rise from 1752.12, and that from 1682.60. Next target is 1916.30 resistance, and then 100% projection of 1682.60 to 1877.05 from 1752.12 at 1946.57.

It has been a quiet week for the Canadian dollar, despite the crisis between Ukraine and Russia, which has captivated the world’s attention. The lack of movement could change on Wednesday, as Canada releases the inflation report for February.

Canada CPI expected to rise

Canada’s CPI looked weak in December, with a reading of -0.1% m/m. However, inflation is expected to have jumped in January, with a consensus of a strong gain of 0.6%. A reading within expectations would indicate that high inflation remains alive and well and will put pressure on the Bank of Canada to take aggressive action in order to curb inflation.

BoC Governor Tiff Macklem has said that more rate hikes are coming in order to lower inflation to the central bank’s 2% target, but other than that hasn’t provided any guidance. Macklem has maintained that inflation is transitory and will ease in the second half of the year but he may have to adjust his stance, as we saw with Fed Chair Powell, if inflation continues to accelerate.

The crisis on the Ukraine/Russia border remains a powder keg that could explode at any time. Somewhat surprisingly, this major geopolitical development has not affected the Canadian dollar, which is a minor currency that is sensitive to risk sentiment. That could change if there are dramatic moves in the next few days, such as a Russian invasion, which could see the currency tumble, or a Russian troop withdrawal from the border, which would be bullish for the Canadian dollar.

There are still hopes that a diplomatic solution can be reached and there have been reports of some Russian troops withdrawing from the border. The solution to the crisis is firmly in the hands of Russian President Vladimir Putin. The West has no intention of supporting Ukraine militarily, so the key question is whether the threat of sanctions is enough to dissuade Putin from starting a war in central Europe.

USD/CAD Technical

• USD/CAD faces resistance at 1.2818 and 1.2873
•  1.2679 is being tested in support for a second straight day. Below, there is support at 1.2595

Markets

More headlines about a Russian pullback hit the wires. Momentum started shifting yesterday after Russian defense minister Shoigu told president Putin that some of the country’s military drills have already ended and others were coming to a close. Foreign Minister Lavrov simultaneously received the go ahead to extend negotiations. NATO is still awaiting official evidence, but risk sentiment on markets nonetheless started improving. Moves accelerated as the US session got started. Brent crude falls from a cycle high of $96/b to $93/b. Main European stock markets rebound up to 1.5%. Core bonds cede ground with both the German Bund and the US Note future again approaching last week’s post-CPI sell-off low. The US yield curve bear steepens with daily changes ranging between +1.5 bps (2-yr) and +6.1 bps (30-yr). The US 10-yr yield moves back at the 2.05% recovery top. The German curve shifts in similar fashion with yields adding 2.8 bps (2-yr) to 5.8 bps (30-yr). The German 10-yr yield sets a new high above 0.3%. The EU 10y swap rate does the same at 0.9%. 10-yr yield spreads vs Germany narrow by up to 3 bps for Italy. The Japanese yen and Swiss franc return part of past session’s gains. EUR/USD trades with an upward bias, changing hands at 1.1354 compared with an 1.1307 open. Eco data included a slightly smaller than expected increase in Germen ZEW investor sentiment, accelerating US producer price inflation (1% M/M & 9.7% Y/Y for headline) and only a small bounce higher in the Empire Manufacturing Survey (coming from the weakest level since May 2020). Details showed relentless price pressure, slightly rising new orders and shipments, higher employment, but a more downbeat assessment on the future (6 months ahead). Markets didn’t respond to the data. EUR/GBP trading is still a proxy of EUR/USD action with the pair rising to 0.8388.

The Kingdom of Belgium launched a new long 30-yr benchmark via syndication (OLO 95 Jun2053). The order book was above €36bn with the debt agency printing a slightly larger than usual size for the very long end: €5bn. Like with last week’s 30-yr Spanish deal, debt agencies seem aware the extremely beneficial financing conditions are drawing to an end as even the ECB is preparing a policy normalization turn to battle persistently high inflation. The deal was priced at 12 bps over the own OLO-curve, compared to initial guidance of +14 bps. Together with an earlier €5bn 10-yr benchmark, the Belgian debt agency now raised €10bn YTD of this year’s €41.2bn OLO funding need. A New Green OLO remains in the pipeline for later this year.

News Headlines

Hungarian Q4 GDP printed at 2.1% Q/Q and 7.2% Y/Y, beating 5.7% Y/Y forecast. The growth composition isn’t available yet, but the statistical office indicated that market services were an important driver. Over the entire year 2021 the Hungarian Economy grew by 7.1%, following a -4.7% contraction due to the pandemic in 2020. Already before the publication of the preliminary growth data, MNB vice governor Virag said that the MNB will continue tightening policy in a predictable manner as inflation continues to surprise in the upside. Virag warned that economic participants should prepare for a period of sustained higher rates as the MNB will keep a restrictive policy approach even when inflation decelerates later as it wants to anchor inflation expectations. After modest losses over the previous days, the forint today rebounded to the EUR/HUF 355.25 area from opening levels near 357.5.

Polish economic activity in Q4 rose 1.7% Q/Q to reach a level of 7.3% Y/Y, slightly higher than expected. Details on the composition will be published on February 28. Polish January CPI rose 1.9% M/M to be up 9.2% Y/Y (was 8.6% in December). The figure was marginally softer than expected but still marks the highest reading since November 2000. Prices of food and drinks rose 2.6% M/M while prices related to dwellings rose 4.4% M/M, with the latter mainly due to higher electricity and gas prices (8.0% M/M). Transport related costs eased 2.7% M/M but were still 17.5% higher compared to the same period last year. The combination of solid eco data and a better risk sentiment propelled the zloty from an opening level near EUR/PLN 4.5475 to currently 4.5050.

USDCAD is trading around the 50- and 100-period simple moving averages (SMAs), which appear to have hindered the decline from the 1.2800 handle from diving towards the lower regions of the two-week sideways market. The 50- and 100-period SMAs are endorsing an upside trend in the pair.

The Ichimoku lines confirm the neutral bearing and currently do not offer convincing directional forces in the pair, while the short-term oscillators suggest that driving momentum is weak. The MACD is below its red trigger line but slightly north of the zero mark, while the RSI is flirting with the 50 neutral level. The stochastic %K line has bounced a tad higher off the 20 level, but the positive charge is still looking feeble.

If the price climbs above the cloud, initial upside friction could unfold around the red Tenkan-sen line at 1.2741 and the 1.2752 high. In the event the price persists northbound of the 1.2782-1.2796 ceiling, which consists of the recent rally peaks in the last two weeks, the bears may attempt to curb advances of price action between the 1.2635 and 1.2796 barriers. However, should a positive breakout of the range unfold, bullish impetus could stumble around the 1.2813 obstacle before buyers jump to challenge the 1.2830-1.2852 resistance section, moulded by the highs over the second half of December 2021.

Now, the latest bearish trajectory of the pair is presently tackling an area of support between the 50- and 100-period SMAs at 1.2711 and 1.2693 respectively. If the price fails to produce a foothold in this zone, the retreat in the pair may remain heavy with sellers then diving to defy the fortified 1.2635-1.2661 floor of the consolidation. Should this hardened foundation give way, the short-term picture in the pair may start to reclaim its prior negative tilt with the price sinking towards the 1.2553-1.2569 support band.

Summarizing, USDCAD is confined in a sideways trend with a lower limit of 1.2635-1.2661 and an upper limit of 1.2782-1.2796. A decisive bearish or bullish breakout of these boundaries may reveal a clearer price direction.

Dollar retreats but risk-sensitive currencies shine on geopolitics

The latest geopolitical developments seem to be the main market-moving factor in today’s trading session. Specifically, Russia announced that several military drills near the Ukrainian border have ended and some troops have already returned to their military bases on the mainland. This headline relieved investors’ fears about a severe military confrontation and triggered a solid rebound in risky assets while causing a sell-off in traditional safe havens.

Following that news, the dollar started losing ground versus more risk-sensitive currencies but surging US Treasury yields are limiting its downside. Moreover, the Japanese yen and the Swiss franc are also trading lower in the current trading session.

On the other hand, the euro and pound are stronger on the day, benefiting from the risk-on sentiment in the markets. Furthermore, the commodity-linked currencies are also appreciating despite the retreating oil prices.

Nevertheless, NATO secretary-general Jens Stoltenberg stated that although there are grounds for cautious optimism, Russia remains in the position to launch an attack. Therefore, volatility is expected to remain elevated as the rebound in investors’ sentiment could prove to be short-lived.

US stocks head north as war fears fade

Wall Street is set to open higher today despite the rallying Treasury yields as investors are starting to downplay the possibility of a large-scale Russian invasion in Ukraine. More specifically, the Nasdaq, S&P 500 and Dow Jones futures are up 2%,1.5% and 1.1% in pre-market trade, respectively. In addition, most major European indices are in the green today capitalizing on the increasing risk appetite.

In individual stock news, problems seem to pile up for Facebook as the Texas attorney-general sued its parent company Meta over claims that it violated state privacy protections with facial-recognition technology and exploited the biometric data of millions of Texans without their consent. This scandal could both inflict financial and reputational damage on the company.

Oil and gold suffer from easing tensions but for different reasons

WTI futures are down almost 3% in the current trading session as the positive news from the Ukraine-Russia front have relieved worries over further supply disruptions. Additionally, soaring Treasury yields, alongside the improving risk sentiment in the markets are significantly weighing on gold’s safe haven demand.

In the cryptocurrency space, Bitcoin is gaining 5% on the day, currently trading at $44.3k, while Ethereum is up 7%.