FX Insights 3/19

Markets are fully pricing in a 25bps rate hike at this week’s Federal Open Market Committee (FOMC) meeting, shifting the focus to the Fed’s economic forecasts, statement, and press conference—the first for Chair of the Federal Reserve, Jerome Powell. Concerns of trade protectionism have dominated markets the past several weeks, but following the central bank meeting, we may see markets showing concern towards the risks posed by higher U.S. interest rates. In particular, emerging market (EM) and risk-sensitive currencies will find themselves at risk from rising U.S. interest rates. Narrowing credit spreads may reduce the attractiveness of higher yielding EM currencies, and if accompanied by intermittent equity volatility, the effects could exacerbate deleveraging of EM assets. Furthermore, the discussion of wider tariffs on China poses a risk to those markets heavily linked to its economy.

The Bank of England also meets this week amidst a busy schedule for the UK economy. The Bank is widely expected to hold its policy this Thursday but markets are pricing an 80% chance of a rate hike in May. Inflation data released for February is expected to show consumer prices easing by 0.2% year over year, while retail sales for the same month are expected to see slight gains. Recent diplomatic tensions between the UK and Russia have not merited much response from markets, but any potential trade actions resulting from the dispute could introduce additional risks to the UK economy. One tension that has taken an apparent turn for the better is that between the UK and the EU as the two parties negotiate potential trade agreements. The EU has conceded that the UK can now negotiate individual trade agreements with member states during its exit. This apparent break of a deadlock has been Pound supportive.

Looking more closely at Europe, European Central Bank President, Mario Draghi, maintained his dovish stance last week reiterating that any exit from quantitative easing will be gradual. Moreover, while inflation was on the right track, uncertainties over the outlook remained. In summary, he notes that monetary policy will still need to be “patient, persistent, and prudent.” The Canadian dollar has continued to underperform in the past several weeks and will likely maintain a negative bias with few drivers this week to catalyze upward sentiment in the currency. Prospects of a near-term rate hike have faded, and despite recent concessions in the US steel and aluminum tariffs trade fears still cloud the economy’s outlook. February’s consumer price index headlines data released this week, which is expected to show inflation increasing to 1.9% annualized. However, any hopes that better than expected inflation may affect near-term interest rate policy have been dampened by the Bank of Canada Governor, Stephen Poloz’s dovish remarks last week.

A land sale scandal embroiling Japanese Prime Minister, Abe Shinzo’s administration has brought domestic politics back into focus for the yen. Abe’s leadership of the Liberal Democratic Party now begins to look more questionable as he seeks another three year term. Coupled with political unrest in the U.S. and early stock market volatility this week, the continuing fallout from the scandal could help the yen see further appreciation from growing risk-off sentiment.

Sources: Bloomberg, Wall Street Journal, Reuters, Barclays, Bank of America, Econoday, 4cast

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