FX: Watch UK and CA Rate Hike Bets

By Kathy Lien

U.S. stocks extended their gains on Tuesday and the improvement in risk appetite drove investors out of safe haven currencies into riskier ones which explains why the U.S. dollar ended the day lower against all of the major currencies despite renewed gains in Treasury yields. Ten year rates are at the cusp of testing new 4 month highs which should have been positive for the greenback. In some ways it was because the dollar incurred most of its losses in Asia and Europe with the greenback recovering during New York trade. No major U.S. economic reports were released today but Federal Reserve officials expressed concerns that the labor shortages may continue past the pandemic. The same could be true for inflation, at least until there’s relief in supply chain shortages.

Inflation will be on everyone’s minds tomorrow when the U.K. and Canada release consumer price reports. It is no secret that everyone is worried about inflation. Raw material prices are surging (oil, cotton, copper) and they are finding its way into other parts of the economy. More specifically, in the coming months groceries, gasoline and heating fuel costs could rise. As we head into the holidays, supply chain shortages could lead to higher prices for toys and other gifts. Some central bankers insist that inflationary pressures are transitory but a growing number acknowledge the possibility of price pressures remaining high for longer.

Hawkish comments from Bank of England officials this month sent U.K. gilt yields and sterling soaring. According to futures instruments, 15bp of tightening is fully priced in this year with a full 1% yield for 2022. GBP/USD rose to its strongest level in 3 weeks on Tuesday with further gains likely if tomorrow’s CPI report surprises to the upside. There’s a good chance that price pressures could exceed expectations because just this Sunday central bank Governor Bailey warned they may “have to act” to curb inflationary forces if they do not let up.

Inflationary pressures should also be on the rise in Canada. According to the latest IVEY PMI report, price pressures rose strongly in the month of September. USD/CAD hit fresh 3 month lows in very early New York trade before recovering most of its losses. Between a post pandemic recovery and rising oil prices, the outlook for the Canadian dollar is bright. If CPI ticks higher, investors could start looking for a rate hike sooner than the Bank of Canada’s no early than second half of 2022 forecast.

The best performing currencies today were the Australian and New Zealand dollar. The muted RBA minutes did not seem to hurt Aussie. The central bank expects growth returning in fourth quarter after the Delta outbreak sent states into lockdown. However they expect the recovery to be weaker than last year / beginning of this year which explains why they do not expect to raise interest rates until 2024. Monetary policy divergences become stark when we see the RBNZ hiking rates, the BoE looking at end of 2022 tightening and the RBA signaling no rate hikes until 2024.

For the U.S. and Eurozone, the main focus on Wednesday will be the Federal Reserve’s Beige Book report and revisions to Eurozone CPI. With the U.S. gearing up to taper asset purchases, we expect an optimistic Beige book report.