August 2022: FX Outlook
Economic Outlook and Summary
July ended with the Wall Street staging an impressive performance. The Nasdaq finished with an 11.7% gain, while the S&P 500 Index rose 7.97%., despite the Fed matching June’s rate increase with another 75 basis point hike on July 27.
The Fed’s rate hike was puny compared to the Bank of Canada’s (BoC)100 bp increase July 13, which surprised markets but failed to provide the Canadian dollar with a lasting benefit.
The European Central Bank (ECB) followed the BoC’s lead on July 21 and surprised markets with a 50 bp rate hike, double what President Christine Lagarde suggested just a week before the meeting. They also introduced a new tool to address EU country bond price divergences.
The Bank of England was quiet, leaving Prime Minister Boris Johnson’s resignation to drive GBPUSD price action during July. The BoE is expected to raise interest rates 50 bps on Thursday, August 4, while signaling similar increases are likely at future meetings as the Bank acts to tame soaring inflation.
Global markets shifted their attention from the war in Ukraine to a possible “soft economic landing” in the US, with many pundits already talking about the Fed’s first rate cut occurring as early as January 2023.
Traders will be laser-focused on US economic data and speeches from Fed policymakers for clues to how the Fed will react at the September 21 meeting.
The USD and Federal Reserve
The Fed hiked rates 75 bps, committed to reducing inflation, and promised further hikes ahead, which would be dependent on data. The Consumer Price Index and Nonfarm payrolls are the most critical data points, and policymakers will get to two sets of results before the next meeting.
Analysts and economists are debating the pivot point for when the Fed shifts from hiking rates to cutting them. Some believe the first rate cut will be in January 2023. Others, including some Fed officials, say it is far too early to discuss pivoting.
San Francisco Fed President Mary Daly said the Fed was “nowhere near” done raising interest rates. Minneapolis Fed President Neal Kashkari just shook his head, saying he didn’t understand why markets were reducing expectations for Fed rate increases.
The US dollar index drop from its July peak is merely a correction while prices are above 105.00. A move below that level targets 101.00.
August is often known for poor liquidity and volatility as many traders are on vacation, an environment ripe for rumours to roil markets.
The Canadian Dollar and Bank of Canada
The Bank of Canada delivered a jumbo 100 bp rate hike as Governor Tiff Macklem acted aggressively to lower inflation. To that end, Canadian rates are now in the long-run neutral range. He recently predicted that the CPI level would probably have a seven handle for the rest of the year which implies further rate hikes ahead, and that is providing the Canadian dollar with some support.
Despite the Bank of Canada’s actions, the Canadian dollar remains on the defensive due to many external factors, including ongoing supply-chain disruptions, geopolitical tensions, and slowing growth in China.
The Canadian dollar is also at the mercy of global risk sentiment, which is predicated on geopolitics and the US interest rate outlook, although steady to firm oil prices provide some mitigation for those risks.
West Texas Intermediate prices declined in a ragged fashion throughout July and are trading with a negative bias in early August. Prices are weighed down by higher US crude inventories, partly due to lower gasoline demand, with Opec’s meager output increase (100,000 b/pd) considered more an issue of Opec production problems rather than an effort to lower prices.
Libya has increased production while China’s slowing economy is seen as a drag on demand. WTI technicals are bearish below $103.00 with a drop below $90.00 targeting $80.00/b. A break above $103.00/b suggests further $90.00-$112.00 /b range trading.