Today's FX Comment

October 10, 2023

Good morning and for those of you who enjoyed a long weekend, welcome back.

As the tragedy (what else can you call war) continues to unfold in Israel we have seen a shift in market sentiment. The initial market reaction Sunday night was risk off and I think many expected that to be the case. I'm not so sure as many would have guessed we would get the rapid turn we have seen in risk sentiment with North American equity markets finishing in the green yesterday and stock markets generally trending higher again overnight. I think the shift can be attributed to three things:

- the market's belief that the war in Israel will have a limited impact on global markets

- reports of more planned Chinese stimulus overnight

- a couple of Fed speakers sounding more accommodative yesterday with the Fed's Logan and Jefferson both noting that rising bond yields may mean the Fed has to do less (no kidding) with Vice Chair Jefferson also stating that he was mindful of lag effects of past hikes and whether there is a need for further policy tightening.

A couple of follow up points:

- the Bank of Canada should probably listen to what the Fed is saying with respect to yields, the Canada 5 year yield is up 159bps since the lows in March, anyone NOT think that leads to tighter conditions?

- We have mentioned it here previously, get used to central banks all adopting that "Table Mountain" view of interest rates. It is not about that one last rate hike or how high rates go, but rather how long you keep rates restrictive.

Overnight, Asian indices were mostly higher and it was good news/bad news out of China. Bad news first, more problems for Country Garden with the company issuing a filing that liquidity is very tight and that it cannot meet a payment deadline on a HKD $470M debt - that pesky Chinese real estate issue just won't go away it seems. Good news, reports that China is considering new stimulus and higher budget deficit to GDP ratio to help meet their 2023 GDP growth target with targeted spending on infrastructure (of course we have heard this story before and we'll believe it when we see it). For now the market and in particular European equities are liking what they are hearing out of China.

As we noted European indices have been given a lift on the back of potential stimulus out of China and a bit more good news this morning. We often focus on higher CPI prints and the thought of sticky inflation but better results out of Norway and Denmark today where there were big downside misses in inflation data (headline CPI +.9% YoY in Denmark!). Maybe it gives Europe some hope that inflation will cool sooner than current forecasts.

The US 10 year yield is lower, crude has steadied (really given the decline in WTI from $95 to a close of $82.79 last Friday you might have expected a bigger jump in the price of oil with the events that unfolded over the weekend and continue to unfold) and futures point to small gains on the equity open in North America. The US NFIB Small Business Optimism Index was released earlier this morning and dipped once again. As the NFIB notes, September’s reading was the 21st consecutive month below the 49-year average of 98. Key finding: small business owners expecting better business conditions over the next six months deteriorated six points from August to a net negative 43%, off the lows from earlier this year but as the NFIB notes, definitely at recession levels. More reason for the Fed to be patient.

FX thoughts:

JPY - The Yen has lost some of its safe haven luster as equities have steadied pushing USDJPY back to 149. The pair did have a brief test lower overnight on reports that the BOJ is considering raising its current year core CPI forecast from 2.5% to 3.0% but the market has heard these stories before and isn't buying into it all that much. One thing the market likely is buying into: the threat of intervention above 150 and I think gains in USDJPY might just be capped. Time for longs to take profit, time to look at downside USDJPY structures. Support 148.30 and 147.50.

AUD - Higher equities/better risk sentiment is helping the Oz today and of course if those reports of stimulus out of China turn out to be true it would be a huge boost for the currency. Resistance .6415 and .6470, support .6360.

EUR - The market tends to crush hope and "hoping" something happens typically is not a great strategy but the market is hoping we see that stimulus out if China and is hoping that helps give the Eurozone economy a lift. That is giving stocks a lift today and is lending some support to the Euro as well although resistance between 1.0590-1.0610 has capped gains for now.

GBP - The BOE's Mann was her usual hawkish self stating that monetary policy had to be aggressive to address any drift in expectations as well as actual inflation but the market pretty much ignored the comments, they know she is likely outvoted. All about equity market performance in the near term. Resistance 1.2270-90, support 1.2110.

CAD - The odds of a BOC rate hike this month have drifted lower with 8bps currently priced in. It should be zero in my opinion as you know I think the Bank is done. As the Bank says on their website: "When we adjust our policy interest rate at the Bank, we don’t expect immediate results. It usually takes 18 to 24 months to see the full effects." I would argue you don't start counting from that first hike in March 2022 but rather July of that year when the Bank took rates above the pre-covid 1.75% level. By their own account that means the impact of rate hikes won't be felt until sometime between January and July 2024. Throw in the fact that:

- the 5 year yield is up 159bs since March of this year while the 10 year is up 136bps over the same period = tighter conditions

- GDP was flat in Q2 and will likely be flat in Q3 = undershooting BOC forecasts

- we know BOC rate hikes are feeding into higher mortgage costs which =? feeding into inflation, not to mention more and more mortgages keep rolling over at higher rates, the Globe and Mail ran a tell tale article last Friday: "We’re barely making it": Eight Canadians reveal the pain of soaring mortgage costs.

Patience is the key word for the BOC now. All that being said, IMM data shows the market short a fair bit of CAD. Oil has steadied itself (not for the best reasons) and if equities can build on gains the pain trade is lower USDCAD. Support nearby at 1.3580 followed by 1.3520.

Good luck.

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