It is a brand-new year, but the market will be dealing with the same old themes in the early part of 2023. The debate about when and where US interest rates will peak will continue with every inflation data-point, which in turn will drive equity market direction. Analysts are undecided about US recession risks. Those at JP Morgan do not believe a recession will occur while economists at RBC and Blackrock believe a recession is foretold.
2022 was a horrible year for global stock markets. The S&P 500 index, the favourite risk sentiment barometer for traders, lost nearly 20% due to the Fed hiking interest rates by 400 bps in an effort to tame surging inflation. Those hikes helped boost the US 10-year Treasury yield from 1.5% on January 5, 2022, to 4.34% by November 30, before Fed rate peak chatter knocked yields to 3.88% by December 30.
Russia’s war with Ukraine, China’s lust for Taiwan, and Iran’s aspirations for nuclear weapons are major geopolitical issues which will undermine global economic growth, support oil prices, and keep risk sentiment elevated in 2023.
The USD and Federal Reserve
The aggressive Fed rate hikes powered the US dollar to an 8.37% gain against the US dollar index in 2022. The Japanese yen was the worst performing major G-10 currency, losing 13.9% which was a vast improvement from its October 21 peak loss of 31.9%.
The Federal Reserve raised US interest rates by 0.50% on December 14, as widely expected. It was the sixth consecutive rate hike in 2022 and the most aggressive tightening in forty years. Fed Chair Jerome Powell reiterated that the Fed was committed to price stability and that there was “more work to do.” The Dot-plot projections indicated as much as policymakers suggest the peak rate is 5.0-5.25%.
The Fed is in no hurry to lower rates and if the dot-plot projections prove to be accurate, there will not be any rate cuts in 2023. Mr Powell agrees saying “Historical experience cautions strongly against prematurely loosening policy. I wouldn’t see us considering rate cuts until the committee is confident that inflation is moving down to 2% in a sustained way.” That view will mitigate US dollar losses in the near term.
Inflation measures like CPI, PCE, and the average hourly earnings component of the January 6 nonfarm payrolls report will be major market drivers in January.
The Canadian Dollar and Bank of Canada
The Canadian dollar was choppy but rangebound in December. It closed out the year with a 7.2% loss against the US dollar. The domestic currency was the weakest of the commodity currency bloc (AUD, NZD, CAD) partly because the antipodean currencies benefitted from China’s plans to reopen its economy while US recession fears weighed on the Canadian dollar.
The BoC hiked its overnight rate by 50 bps to 4.25% on December 7, then indicated that future rate hikes would be data dependent a somewhat dovish outlook. The rate increase left the BoC overnight rate 0.25% lower that the fed funds rate which supported USDCAD. That may change at the next BoC monetary policy meeting January 25, when rates are expected to rise 25 bps, providing Canadian inflation remains at elevated levels.
USDCAD trended lower since mid-October and while prices are below 1.3700, the risk is for further losses to 1.3200.
Oil Price
Oil prices saw a volatile, choppy 2022 thanks to Russia’s invasion of Ukraine and Opec’s manipulation of prices. Despite those moves, West Texas Intermediate oil prices finished a just 4% higher than they were at the start of the year. Opec predicted world oil demand would rise by 4.2 million barrels/day in 2022. It didn’t happen. In December, the cartel said 2022 demand rose 2.2 m/bd and would be unchanged in 2023.
Germany and Poland halted all imports of Russian oil by pipeline, effective January 1, 2023, That move, combined with new EU energy sanctions on Russia which come into effect February 5 and an expected uptick in crude demand from China, may drive WTI prices higher.
Forecast Table
Bank 2023-USD/CAD Q1 2023-USD/CAD Q2
Scotiabank* 1.35 1.36
BMO 1.35 1.34
CIBC 1.36 1.34
TD Bank* 1.37 1.39
National Bank 1.35 1.30
*Forecast is based on last month. Forecast Table is for mid-market rates, and subject to change anytime.
