September 2022: FX Outlook

Economic Outlook and Summary

August ended on a negative risk sentiment note. Fed Chair Jerome Powell delivered a hawkish interest rate outlook at the August 26 Jackson Hole Symposium, which buried all hopes of an early pivot.

Subsequent comments by other policymakers suggested the fed funds rate would be above 4.0% for all 2023.

The US dollar was in demand for most of the month and closed August 31 with gains across the board. The British pound lost 4.27%, the Japanese yen fell 4.05%, and the Canadian dollar dropped 2.19%. August is a prime holiday month in Europe and North America, which sapped FX liquidity and exacerbated US dollar gains.

The FOMC meeting is on September 21, and speculation about the outcome will dictate market direction until the statement and press conference.

The US dollar will continue to be bought due to diverging economic outlooks. European and UK economies are reeling due to soaring inflation and a crippling energy crisis, thanks to Russia’s invasion of Ukraine. The US has escaped the worst of the energy crisis, and its economy remains robust.

There is no reason to believe that US Treasury yields will retreat much below 3.20%, which should ensure a negative equity bias and a strong US dollar in September.

The USD and Federal Reserve

The Fed is hawkish. Fed Chair Powell’s Jackson Hole speech confirmed it, and in case you didn’t get the message, he repeated it on September 8, in a panel discussion at the Cato Institute in Washington. He reiterated that Fed officials are committed to fighting inflation, and recent US economic data suggests the economy can easily absorb more rate hikes.

The Fed is expected to hike rates by 75 bps on September 2, and bond traders have got the message. The US 10-year Treasury yield soared from 2.58% at the beginning of August to 3.34% on September 6. That rally sent Wall Street tumbling, with the S&P 500 index losing 3.97% in August. The S&P 500 will consolidate in a 3900-4020 range until the Fed meeting.

The US dollar index surged 2.85% in August and is expected to remain elevated throughout September.

The Canadian Dollar and Bank of Canada

The Bank of Canada followed its 100- basis point rate hike on July 14 with a 75 bp hike on September 7 and said that rates would rise further. It wasn’t a surprise since Tiff Macklem adopted an inflation-fighting persona and claimed he was committed to bringing inflation down to the 2.0% target.

The statement said that the BoC was concerned about “the broadening of price pressures” while the economy  “operates with excess demand” and tight labor markets.

The news didn’t do anything to lift the Canadian dollar. USDCAD traders remain fixated on the prospect of sharply higher US interest rates remaining elevated for an extended duration.

USDCAD traded in a 1.2730-1.3070 for all of August, then broke to the topside at the Start of September. Technical analysis suggests a downside floor at 1.3000 with modest resistance at 1.3230.

Oil Price

Oil prices are undermining the Canadian dollar. West Texas Intermediate traded in an $85.70/barrel-$9750/b range in August, then dropped through the floor in early September. The short-term WTI outlook is negative, with the break below $85.70 warning of further losses to the 2022 year low of $70.80.

The negative WTI sentiment stems from China’s aggressive Covid-fighting measures. China has a “zero-tolerance” covid policy which led to over 325 million people in 14 cities being placed under some form of restrictions, including total lockdowns. Traders concluded the procedures would aggravate the global growth slowdown and oil demand would plunge.

Opec’s announcement of a 100,000 barrel/day production cut effective October 1 was a nonfactor but news that US crude inventories rose in the first week of September weighed on prices.

Forecast Table

Forecast Table is for mid-market rates, and subject to change anytime.