Daily Commentary | 06/09/2017
Fed officials express concerns on inflation and rate hikes
• The dollar came under selling interest yesterday, while the probability for another Fed hike this year slid, following remarks by three Fed officials who expressed concerns with regards to low inflation and noted that further tightening should be delayed. Specifically, Fed Board Gov. Lael Brainard appeared concerned that low inflation is due to depressed underlying price pressures, and said that the Committee should be cautious on rate hikes until inflation is back on track to achieve target. Minneapolis Fed President Neel Kashkari went even further. He said that maybe the rate hikes over the past 18 months are doing real harm to the economy. Both Brainard and Kashkari are at the dovish end of the FOMC spectrum, but given that they are among those who actually vote on whether the committee should increase interest rates, their harsh comments sparked a market response. Even Dallas Fed President Robert Kaplan, who is seen as a centrist, suggested that they can afford to be patient because of low inflation. Although he kept the door open for another hike this year, he said he wants to see more information.
• The cocktail of these comments make the next CPI data, due out on the 14th of September, even more important we think, and enhances our view that inflation is the main determinant on whether the Fed will indeed proceed with another rate hike this year. Expectations are for the headline rate to have ticked up, but for the core rate to have ticked down. In our view, as long as core inflation remains subdued, we doubt that the headline print will be enough to drag forth expectations for the next Fed hike. Actually, we believe that this may be the reason for the number of concerned policymakers around inflation to increase, and for the hike-by-year-end probability to drop further.
• USD/JPY continued to tumble yesterday and broke briefly below the 108.70 (R1) key barrier, which acted as the lower boundary of the sideways range the pair has been trading within since the 28th of July, between that level and the 111.00 zone. Given that the rate oscillated around that level overnight, and that now is trading only fractionally below it, we would prefer to wait for a clear close below that hurdle before we get confident on further declines. A clearing of that level could initially aim for the 108.30 (S1) line, marked by the low of the 29th of August, where a dip could pave the way for our next support of 107.75 (S2).
Bank of Canada policy meeting takes center stage
• Today, all eyes will be on the BoC rate decision. Since the latest gathering, when the Bank judged it right to increase interest rates, data showed that even though headline inflation slowed in June, it rebounded in July to fractionally below the Bank’s forecast for Q3. Although another rate hike this year is more-than-fully priced in, according to Canada’s Overnight Index Swaps, we don’t expect a rate increase to come at this gathering. We believe that policymakers may prefer to wait for August’s and September’s CPI prints before they arrive to safe conclusions that inflation is progressing in line with their forecasts. We expect them however to maintain their hawkish bias. Indeed, the economy’s output gap continues to narrow at a steady pace and is expected to close entirely by the turn of the year, which implies that price pressures are likely to pick up afterwards.
• Having said that, we view the risks surrounding the Loonie’s reaction at the time of the gathering as asymmetrical. If the Bank appears hawkish as we expect, the Loonie is unlikely to strengthen much, as this will simply confirm the already elevated market expectations with regards to another hike in 2017. We expect USD/CAD to settle at around 1.2430 (R1) ahead of the release, or near the prior upside support (now turned into resistance) line taken from the low of the 26th of July. In the case of the expected scenario, the pair could slid back down, and perhaps challenge once again the 1.2335 (S1) support. On the other hand, a softer-than-previously language could catch investors off guard and drag notably down rate-hike expectations. The Loonie may collapse. USD/CAD could surge, break above 1.2430 (R1) to initially target the 1.2500 (R1) obstacle. If the bulls are proven strong enough to overcome that level as well, we may see them driving the battle towards 1.2600 (R3).
As for the rest of today’s events:
• In the US, the ISM non-manufacturing PMI for August is due out and the forecast is for the index to have risen after declining significantly in July. This could help the dollar recover some of its latest losses. The nation’s trade balance is also coming out. We get trade data for July from Canada as well.
USD/JPY
• Support: 108.30 (S1), 107.75 (S2), 107.00 (S3)
• Resistance: 108.70 (R1), 109.40 (R2), 109.85 (R3)
USD/CAD
• Support: 1.2335 (S1),1.2260 (S2), 1.2120 (S3)
• Resistance: 1.2430 (R1), 1.2500 (R2), 1.2600 (R3)