CAD
After May’s inflation data surprised to the upside, the April GDP reading released later today is likely to be key for Bank of Canada expectations, and specifically, the prospect of the Governing Council easing policy in July. Another overshoot is likely to see the odds of back-to-back rate cuts drop below the 40% currently priced by markets, with this having stood at 70% to start the week. That said, with markets expecting to see the economy expanding 0.3% MoM and 1.1% YoY, we are inclined to think that this is a high bar. Admittedly, the 0.7% MoM retail sales growth seen in April was strong. But the economy also shed jobs in the same month, a point emphasised by yesterday’s SEPH payrolls print of -22.7k. This is hardly a sign of economic resilience. We also note that more often than not since the start of 2023, monthly GDP data out of Canada has undershot expectations. All told, even a reading that meets expectations would suggest an output gap that remains negative, weighing on inflation, an eventuality that should keep the door open to a BoC rate cut next month. As a result, anything but a significant overshoot should see markets add to BoC easing bets. With this in mind, and against a backdrop of broad dollar support following last night’s Presidential debate, the loonie is likely to remain under pressure unless the Canadian economy significantly outperforms expectations.
USD
Volatility was once again syphoned through emerging markets yesterday, where investors positioned for a potential Trump victory in the first presidential debate through short MXN positions, while the South African rand sold off 1.5% as the ANC-led coalition still failed to produce a functioning cabinet, with its coalition partner the Democratic Alliance threatening to withdraw its support. We have expressed caution in both currencies in recent weeks, even as they staged moderate comebacks. Concerns over constitutional reform and more hawkish US trade policy has led us to revise up our USDMXN forecast to 18.3 even as the currency was trending back to the 18.00 handle, while we noted cautious optimism over the South African political climate, noting the real test is whether the unprecedented coalition could effectively govern. In DM markets, the dollar traded under moderate pressure as the final reading of Q1 GDP saw personal consumption downgraded a further 0.5pp to an annualised rate of 1.5%.
The main event for markets yesterday, however, was the first US Presidential debate of this electoral cycle. Occurring historically early, the debate was set to test both leaders competencies and provide markets with the first clear distinction of who is leading the race given neither candidate has taken a clear polling advantage. The gamble by the Biden administration to call the early debate seemingly backfired, however, with concerns over Biden’s cognitive ability leading this morning’s periodicals. In fact, a snap poll conducted by CNN after the debate had Trump winning with 67% of the vote. As we noted in the run-up to the debate, both the perceived winner and their stance on fiscal and trade policy would be crucial for markets. Trump’s victory, which has reportedly sent the Democrats in search of a new presidential candidate, will likely be more dollar supportive as a result of both looser fiscal policy and hawkish trade policy. While we believe it remains too early for spot markets to fully factor this outcome, the outcome has kept the dollar bid into this morning’s European session. With politics remaining front and centre heading into the weekend with the first round of the French election on Sunday, we suspect the dollar will remain in favour, even as May’s PCE data this afternoon confirms the disinflation signal from the earlier CPI report.
EUR
Positioning into the first round of the French election over the weekend dominated European markets yesterday, with French stocks closing a percent lower as the spread in French bonds over their German counterpart widened to the most since 2012. As we laid out in our election webinar on Tuesday, there is considerable uncertainty over how the national polls will translate into seats in the National Assembly, with the outcome of Sunday’s vote set to shed some clarity on the matter. The latest poll by Opinion Way has National Rally winning 37% of the vote, followed by the Left Alliance at 28% and Macron’s centrist party at 20%. Our base case remains that Marine Le Pen’s National Rally party takes the largest share but falls short of an outright majority. This should narrow bond spreads and release some of the pressure on EURUSD, especially if policies to cut taxes and pension ages are scaled back as a result. But risks of a larger seat haul or a swing to the left poses significant downside risks to markets. Given this uncertainty and the skew of risks, we suspect defensive positioning will remain prominent today in European markets, with the euro likely to remain under pressure. While a softening in the US PCE data this afternoon may prevent EURUSD slipping into freefall, we doubt the single currency can make it into the weekend above the 1.07 handle. In terms of positioning, we continue to favour short EURGBP and EURNOK as election hedges, even as the latter remains under pressure alongside other high beta FX.
GBP
Sterling once again found itself adrift on Thursday, rising one tenth against the dollar while sliding by the same amount against the euro. Perhaps surprisingly, this came against the backdrop of a warning from the Bank of England in their latest Financial Stability Report, saying that “The full impact of higher interest rates has not yet passed through to all mortgagors”. This not only underscores a view that policy is set to be a headwind to the UK economy in the coming years, but we also think it offers a subtle steer on the Bank’s more immediate actions as well. Implicit in yesterday’s report was an idea that the lagged pass though of monetary policy to the real economy means that rates could continue to weigh on inflation, even as the Bank begins to ease. This would be in line with commentary from both Governor Bailey and Chief Economist PIll heard prior to the purdah period. Moreover, if our assessment is correct, then markets are likely underpricing the likely speed of BoE easing. This morning, however, it is final GDP readings that are in focus for sterling, with Q1 growth revised up to 0.7% on a QoQ basis. This has seen the pound receive a modest boost to start the day, as the focus now turns to election risks. With markets having to digest the US Presidential debate last night, and with a UK election on July 4th sandwiched between the two rounds of the French National assembly elections on June 30th and July 7th, this could well inject some volatility in both GBPUSD and GBPEUR over the coming days.
This content was originally published by our partners at Monex Canada.