February 2023: FX Outlook
Economic Outlook and Summary
January closed with traders in an optimistic mood. The S&P 500 finished the month with a 6.18% gain and the US dollar dropped across the G-10 spectrum.
Analysts and traders were feeling rather smug, believing that their outlook for inflation and US interest rates was more realistic than the Feds hawkish view. Bond prices and the US dollar fell while Wall Street stocks rallied despite policymakers warning that inflation was too high, and rates needed to remain restrictive for some time.
The market view was reinforced by the Bank of Canada hiking rates by 25 bps on January 25, then saying they were done.
The market optimism occurred even as the Russian war with Ukraine intensified. Western nations planned a large influx of high-tech weapon deliveries for Ukraine, including tanks and Patriot missile defense systems. Russia claimed it was fighting a proxy war with NATO and talked of nuclear weapons. Traders ignored the drama right until the end the month.
The USD and Federal Reserve
The February 1 FOMC meeting was highly anticipated. Traders were wanting a dovish outcome but the result supported both bulls and bears.
The FOMC statement was somewhat hawkish, but Fed Chair Jerome Powell muddled the message at his press conference. He started out aggressive, saying that more rate hikes were needed and adding he didn’t see the Fed cutting rates in 2023.
But in the Q&A session many of his answers were rather dovish and played to those traders looking for that bias. Powell said, “We can now say I think for the first time the disinflationary process has started.” The message was further blurred when in response to a peak rate question he said it was “certainly possible” that rates would stay below 5.0%.
Mr Powell’s hawkish view got a huge boost from the surprisingly strong report nonfarm payrolls report which showed 517,000 new jobs and the unemployment rate falling by 0.2% to 3.4%. Traders were knocked for a loop. By days end the S&P 500 index was sharply lower and the US dollar substantially higher.
Market action in February will be determined by how traders interpret incoming data against a backdrop of speeches and interviews by various Fed officials.
The Canadian Dollar and Bank of Canada
The Canadian dollar gained 1.17% in January, outperforming the New Zealand dollar (0.42%) but lagging the Australian dollar (1.26%).
The Bank of Canada’s decision to announce it would be pausing rate hikes served to reinforce the USDCAD floor in the 1.3250 area. A decisive break above the 1.3480 level sets the stage for a retest of the 1.3700 area while a move below 1.3250 targets 1.3000.
The Bank of Canada will release the minutes from its January 25 monetary policy meeting on Feb 8. It’s a new thing and came at the behest of the IMF, which wanted BoC guidance to be more in line with the other major central banks.
Canada’s employment data is due on February 10 and job gains are expected at 17,300 compared to Decembers 104,000 gain. Nevertheless, the data’s impact on USDCAD trading will be fleeting as it is US data and the outlook for US rates that dictates the direction.
West Texas Intermediate (WTI) prices rallied from the beginning of January until the middle of the month and then erased the entire move in the first few days of February. The latest decline in prices is considered a “technical “ drop, as the rising US dollar has forced some speculators to trim positions, Even so, analysts do not expect at lot of downside below $69.50 support, a level last seen in January 2022. That’s because Opec and the International Energy Agency (IEA) are forecasting higher prices due to the latest round of Russian oil sanctions which start February 5 and a rebound in Chinese demand.
|Bank of Montreal
Forecast Table is for mid-market rates, and subject to change anytime.