The Canadian Dollar Shines in a Mostly Consolidative FX Market Ahead of the Flurry of Central Bank Meetings

Overview: Ahead of the flurry of central bank meetings, starting with the Federal Reserve and Brazil tomorrow, the dollar is largely consolidating in narrow ranges. The euro, sterling, and yen are trading slightly heavier, while the dollar bloc and Scandis enjoy a firmer bias. The Canadian dollar stands out as is trades at its best level since mid-August ahead of its CPI report and despite a diplomatic dispute with India and the failure of negotiations to prevent an autoworkers strike starting today. Emerging market currencies are mixed, but of note, the yuan is flat, and the Mexican peso has come back better bid after yesterday's fall.

Japan's Topix and Hong Kong's Hang Seng managed to post small gains, but the other large bourses in the region traded heavily. Europe's Stoxx 600 is slightly firmer today after falling 1.1% yesterday, its largest decline since early August. US index futures also enjoy a firmer bias. The 10-year JGB yield is edging to new highs (~0.71%), while European benchmark 10-year yields are slightly lower. Italy and Greek 10-year yields are off more than two basis points, and Gilt yield is off nearly four basis points. The 10-year US Treasury yield is firmer at 4.31% and the two-year is steady near 5.05%. Gold is firm and around $1935 it is at its best level in two weeks, extending is rebound slightly from the low near $1900 last week. Crude oil is reaching new highs. November WTI reached nearly $91.70. Recall that is settled last month slightly below $83. Average retail US gasoline prices has edged up from $3.81 at the end of August to $3.88 yesterday.

Asia Pacific

Chinese banks set the loan prime rates first thing tomorrow. Even though the benchmark one-year Medium Term Lending Facility (MLF) rate was left unchanged at 2.50% last week, it is possible that the prime loan rates are shaved. Recall what happened last month. The MLF rate was reduced by 15 bp, but the one-year prime rate as pared by only 10 bp (to 3.45%), while the five-year prime rate was left unchanged at 4.20%. The yuan's weakness has not prevented the PBOC from easing monetary policy by lower rates and cutting reserve requirements. We think this is consistent with Beijing trying to moderate the yuan's decline, not reverse it. Many observers talk about the increased role of the yuan, but do not seem to appreciate it cuts both ways. Like the Japanese yen, it may be an attractive funding currency. In 72 of the past 100 sessions, the yen and yuan move in the same direction against the dollar and this year, the two have risen and fallen together about 64% of the time (last year, the co-movement was ~55%).

Japan's external sector kept the economy from contracting in Q2, but this may not be the case in Q3. The August trade figures will be reported early tomorrow, and the trade deficit is set to deteriorate. Consider that in Q2, the deficit averaged almost JPY600 bln a month (~$4.1 bln), a little more than a third of the average deficit in Q1. Exports fell in July year-over-year for the first time since February 2021. Weakening global demand is offset the impact of the under-valued currency. Imports are likely to have fallen (year-over-year) for the fifth consecutive month. This seems to reflect lower prices (but this may be ending as energy and commodity prices are rising again).

While Tokyo was on holiday yesterday, the market was content to consolidate the dollar in a narrow 1/3 of a yen range above JPY147.55. It has been largely confined to that range today. At JPY147, there are about $730 mln of options that expire today. While position-adjusting ahead of the outcome of the FOMC meeting is possible, we suspect continued consolidation is more likely. The Australian dollar also looks poised to continue consolidating. Support has been found near $0.6415. There are options for A$450 mln at $0.6395 that expire today. The market rejected the push toward $0.6475 before the weekend and held below $0.6450 yesterday. Today, it edged up to $0.6460, in quiet turnover. The US dollar recovered from a pre-weekend low near CNY7.2465 to a high yesterday around CNY7.2975 and today reached CNY7.2985. Resistance is seen in the CNY7.3150-75 area. The year's high was set on September 8 slightly below CNY7.35. The PBOC set the dollar's reference rate at CNY7.1733, slightly lower than yesterday. The average projection in Bloomberg's survey was for CNY7.2843. Note that Beijing had imposed curbs on some banks’ importation of gold last month. It seemed that the purpose was like other measures aimed at easing the pressure on the yuan. However, it instead widened the premium for gold trading in China. Calculations by the Financial Times indicated it widened to a little more $120 an ounce. Reports indicate that China lifted the curbs and the premium fell back to almost $75 yesterday. The PBOC has been on a gold buying spree since last November. Some observers argue China is diversifying its reserves away from the dollar and the TIC data showed another drop in China's Treasury holdings (-$13.6 bln), but its declared gold holdings account for less than 1.5% of its $3.16 bln reserves.

Europe

The terms of trade shock that weighed on the euro last year is normalizing and the drag on the euro has shifted (to diverging economies). Consider that the average monthly current account surplus in H1 23 to 13.9 bln euros. In H1 22, the average monthly deficit was nearly 3.2 bln. The July surplus was 20.9 bln euros. Last July, it recorded a deficit of 22.2 bln euros. The eurozone's trade surplus in July was 6.5 bln compared with 36.3 bln deficit. The average monthly trade surplus this year is almost 380 bln euros compared with a deficit of 26.9 bln euros in the Jan-July 2022 period. Separately, August CPI was revised lower but not materially. It rose 0.5% not 0.6% in August, to produce a year-over-year rate of 5.2% rather than 5.3%. The core was unrevised at 5.3%.

The UK reports August CPI tomorrow before BOE's decision on Thursday. Headline CPI is expected to jump by 0.7%, which would lift the year-over-year rate to 7.0% from 6.8% (July). That will be the first increase in the year-over-year rate since February. Still, note that a 0.7% increase month/month brings the three-month annualized rate to about 1.6%. In the previous three months, the annualized rate was over 10%. The core rate may slip slightly. Deflationary forces continue to be evident in producer prices, but it appears to be coming to end, given the base effect, and the firmer monthly readings expected. 

The euro's recovery off the last week's low slightly above $1.0630 stalled near $1.0700 yesterday and today. Sentiment still seems negative, and above $1.07, resistance is likely in the $1.0750-70- area. The momentum indicators are, as one would suspect, given the nine-week drop, stretched, and although they look to be basing, there is nothing compelling yet. However, the two-year rate differential between the US and Germany peaked in late August near 207 bp. It briefly traded below 180 bp yesterday before closing back above it and it is straddling that area today. It has not settled below 180 bp since early August. Sterling initially extended its slide yesterday, reaching $1.2370. It stabilized but was unable to make much headway above $1.2400. Today, it is holding yesterday's low, but has not been able to rise above $1.2400. Options for GBP625 mln at $1.2350 expire tomorrow. 

America

Ahead of the outcome of the FOMC tomorrow, the US reports August housing starts today. After a 3.9% increase in July, a small pullback is expected. Still, the 1.440 mln (seasonally adjusted annual rate) of the median forecast in Bloomberg's survey compares with 1.505 mln starts in August 2022. Permits are seen little changed for the third consecutive month. The futures market sees practically no chance of a Fed hike tomorrow and slightly more than a 30% chance of a hike in November.

Although the Canadian economy unexpectedly contracted by 0.2% in Q2, it appears to be off to a better start in Q3, with an increase in aggregate hours worked and a smaller than expected trade deficit. Attention turns back to inflation today and the August CPI. The year-over-year pace is expected to rise for its second consecutive month, with the median forecast in Bloomberg's survey of 3.8% (from 3.3%). Canada's headline inflation bottomed at 2.8% in June. It finished last year at 6.3%. Unlike the US experience, the underlying core measures are not expected to fall. The swaps market sees an almost 50% chance that the Bank of Canada hikes rates before the end of year. The cash target rate is 5.0%. Separately, note that the Canadian auto workers contract expires. The union is threatening to strike against Ford. The goal is to reach a deal with Ford that GM and Stellantis would be under pressure to accept. Separately, a diplomatic dispute has opened between Canada and India. The Canadian government accuses India's government of having killed a Canadian Sikh a few months ago in Canada.

The US dollar fell by nearly 0.85% against the Canadian dollar last week, the most in three months. The losses were extended to almost CAD1.3470 yesterday, the sixth decline in seven sessions. Although it held the support, we noted near CAD1.3465 (retracement objective and 200-day moving average), today it has been sold to nearly CAD1.3440, its lowest level in a month. The next important chart area is CAD1.3375-CAD1.3400. That said, the intraday momentum indicators are stretched. Initial resistance is seen in the CAD1.3470-80 area. The greenback posted a bullish outside up day against the peso, trading on both sides of the pre-weekend range and settling above its high. There are reports that try to link the peso's weakness with AMLO's fiscal expansion (after being relatively tight fisted through Covid) and foreign selling of Mexico's peso bonds. Still, the dollar trended lower against the peso last week after the budget details were known and bonds were under pressure. The greenback turned high yesterday after approaching MXN17.03. It reached a high slightly above MXN17.18, but it has come back offered today and is trading back to around MXN17.08 in the European morning. Here, too, the intraday momentum is stretched, and we look for the dollar to find support in early North American activity above MXN17.06. 

 

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