Economic Outlook and Summary
May was a choppy month for markets. Ultimately, the fear that US interest rates would rise aggressively, which fueled broad US dollar gains in the first week, gave way to hopes that the Fed would successfully engineer an economic “soft-landing. The US dollar ended the month with losses against the G-10 currencies.
Traders were paying close attention to developments in the Eurozone. Rapidly rising inflation rates led to ECB members talking about rate hikes as early as July. EURUSD caught a bid and rose from a low of 1.0350 to 1.0780 by month-end. The ongoing war in Ukraine appeared to give traders “headline fatigue” and limited the impact of bad news.
GBPUSD ended the month with a small 0.22% gain after falling to 1.2160 in the middle of May following very weak GDP data. The report raised speculation of stagflation as that the Bank of England would need to raise rates to combat inflation even as the economy was slowing.
The USD and Federal Reserve
The Fed is on track to raise interest rates by 50 basis points at the June 15 and July 27 meetings. Fed Vice Chair Lael Brainard agrees. She told CNBC on June 2 that “Market pricing for 50 basis points potentially in June and July, from the data we have in hand today, seems like a reasonable path.” And she doesn’t seem to think pausing rate hikes in September is likely “unless demand really starts to cool.”
The focus on interest rate was underscored in the first part of May when the 10-year Treasury yield soared from 2.92% to 3.20% on May 9. Yields retreated to 2.73% by the end of the month, but talk of steady rate hikes lifted them to 2.93% in early June.
US CPI data due June 10 (forecast 8.2%), Core-CPI (forecast 5.9% y/y) will have a much more significant impact than the June 3 employment data. That’s because the US is at full employment, and even a couple of weak nonfarm payrolls report will not shift the focus from inflation.
The Canadian Dollar and Bank of Canada
The Bank of Canada got even more hawkish in the early days of June. They raised interest rates to 1.5% on June 1, expressed concern that elevated inflation would become entrenched, and warned that the Governing Council is prepared to act more forcefully if needed.
Traders and analysts concluded that the statement put a 0.75% rate hike on the table.
That view was confirmed the very next day with a speech by Deputy Governor Paul Beaudry to the Gatineau Chamber of Commerce.
Mr Beaudry said that broadening price pressures raise the likelihood that the BoC will need to raise rates to the top end or above the “neutral rate.” The BoC describes the neutral rate as the rate “the real policy rate that prevails when an economy’s output is at its potential level and inflation is at the central bank’s target.” Today, the neutral rate is 2.0-3.0%.
The prospect of a 0.75% rate hike as early as July 13 helped drive USDCAD below crucial support in the 1.2620-40 area. If the support gives way, it opens the door to a test of 2022 low of 1.2420. However, a rally above 1.2690 would negate that view.
Oil Price
The Canadian dollar is getting a little bit of support from high oil prices but far less than previously. The main reason is the federal government's fossil fuel policies. According to BoC Deputy Governor Toni Gravelle, they have reduced the level of business investment to half of what BoC models generally implied.
West Texas Intermediate (WTI)gained nearly 15% in May, and the trend is for a test of $122.50 while prices are above $110.00. The gains are due to European Union plans to embargo up to 90% of Russian crude by year-end. Saudi Arabia is reportedly planning to increase production if Russian production falls dramatically.
Forecast Table
Bank 2022-USD/CAD Q2 2022-USD/CAD Q3
Scotiabank* 1.20 1.20
Bank of Montreal 1.26 1.25
CIBC 1.26 1.29
TD Bank* 1.24 1.27
National Bank 1.23 1.20
*Forecast is based on last month. Forecast Table is for mid-market rates, and subject to change anytime.
