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July FX Outlook – ECB and Bank of Canada Center Stage



The USD continued to weaken in June against most currencies, generally falling below the levels seen before the US election. This was partly due to continued disappointment at the lack of any progress from the Trump administration on tax reform or infrastructure spending, but was also related to changing expectations of monetary policy outside the US, with several foreign central banks taking more hawkish/less dovish stances. The ECB is probably in sharpest focus after Draghi’s comments at the ECB forum in Sintra in which he appeared to signal that the ECB would in future be more likely to reduce than increase monetary stimulus – a reversal of the stance that had been in place since the December 2016 pledge to continue asset purchases at EUR60bn a month until the end of 2017. Talk of potential monetary tightening from the Bank of England and the Bank of Canada also undermined the USD against GBP and the CAD, despite political uncertainty in the UK following the June 8 general election. However, USD weakness was less pronounced against the JPY, with no policy change seen imminent in Japan, and against the MXN, with uncertainty about US trade policy still a big factor.

USD Index:

Outlook for July

1) The ECB meeting – July 20

The biggest event in June turned out to be the ECB policy forum in Sintra, at which ECB president Draghi appeared to signal that the ECB was ready to change tack. While it seems very likely that the ECB will carry out the program that it pledged in December last year, and continue to purchase EUR60bn of assets per month until the end of 2017, Draghi’s comments suggest that the purchases will halt in December and that the focus is now starting to switch to the possibility of raising rates rather than the potential for more monetary easing, as the ECB no sees underlying inflation as being on an upward trend despite short term effects from weak oil prices. The market will be focused on the extent to which Draghi indicates a more hawkish stance. Given the reaction to his speech in Sintra the market may now be pricing in the end of asset purchases at the end of the year and is likely to be disappointed if he doesn’t indicate that this is likely.

2) The FOMC meeting – July 26

After raising rates in June there is no expectation of any Fed action in July, and the market is now priced for rates to stay as they are until the end of the year, with another rate hike in December being seen as a possibility but a less than 50% chance. The Fed statement in July, and the minutes of the June meeting on July 5, should give some insight into whether this market stance is correct. Up to now the Fed has encouraged the view that further rate hikes can be expected this year, and given the very modest market pricing for higher rates, the risk look to be that the market will price in some further tightening in response to Fed comments.

 3) The Bank of Canada interest rate decision and monetary policy assessment – June 12

Comments from Bank of Canada senior Deputy Governor Carolyn Wilkins in a speech on June 12 were the main trigger for the strong CAD gains in June. She highlighted encouraging signs of broad-based economic growth in the Canadian economy, and suggested that although inflation was still below target, the Bank of Canada may have to start considering reducing monetary accommodation if they saw inflation accelerating in response to the better economic conditions. The impact of her comments was amplified by comments from BoC governor Poloz on June 28, who said low interest rates had “done their job”. All this has led to the market pricing a Bank of Canada rate hike as around a 60% chance on July 12, so the decision is very much in the balance and will have a big market impact whichever way it goes.

Currency Outlooks

EUR/USD made a key break through the 1.13 level at the end of the month in response to Draghi’s comments at the ECB forum in Sintra. The underlying long term downtrend in EUR/USD is still in place but is now under threat. A break of the 1.1617 high from May 2016 would suggest a bigger reversal of the move down from the 1.40 high of 2014, and quite probably would mark the end of the long term downtrend from above 1.60 seen before the financial crisis hit in 2008. It is probably a little too soon for such a key break. While the ECB is sounding less dovish, significant policy adjustments seem to be off the agenda for the moment, and while US data has been a little disappointing, the Fed still sounds quite likely to continue its hiking cycle, and the Q2 data is looking a little stronger. A major break may therefore be hard to achieve. However, in the absence of news from the Trump administration that has a significant impact on US yields, there seems little reason to expect a major reversal of the recent EUR/USD gains. While 1.16 may be out of reach for now, a correction seems unlikely to dip below 1.12.

June EUR/USD Performance:

The UK general election on June 8 saw the Conservative Party lose its absolute majority and now has to rely on the support of the 10 MPs of the Democratic Ulster Unionist party (DUP) to pass legislation. This was a major surprise and a big defeat for PM May who had called the election with the intention of securing a larger majority. However, although GBP/USD initially fell sharply on the news, it has subsequently recovered above pre-election levels, helped by indications from the Bank of England that a rate hike is being considered. The June meeting saw the Bank vote 5-3 for no change, with three members voting for higher rates. Subsequently, comments from chief economist and MPC member Andrew Haldane suggested he may be close to voting for a rate hike as well, while governor Carney’s comments at the ECB Sintra forum also suggested he is not as committed a dove as he had previously indicated. However, one of those who voted for a rate hike, Kristin Forbes, has now left the committee so the Bank may still fall short of a majority for a rate hike at the next meeting in August. In the absence of such a hike, the GBP/USD recovery looks likely to struggle to extend beyond the May high of 1.3048, which is the highest level since September 2016, given the still weak growth numbers and the political uncertainty surrounding the UK. Last September’s high of 1.3447 should be well out of reach. Nevertheless, unless the USD stages a general recovery it will be hard for GBP/USD to fall far ahead of the August MPC meeting (there is no meeting in July) and the recent post-election low of 1.2590 looks unlikely to be tested. Brexit news could be a wild card, as could any news on the Conservative leadership. Although May looks likely to remain in place in the short term, she is widely expected to be deposed before too long. However, it is not clear such a challenge would be negative for GBP.

June GBP/USD Performance:

The CAD remained very strong through June on the back of the comments from deputy BoC governor Wilkins and governor Poloz, with USD/CAD hitting a new low for the year on June 30. The key focus is now on the July 12 BoC meeting, with a rate hike now seen as more likely than not. If rates are raised, expect the downtrend to be extended to 1.28, but CAD strength may be harder to extend beyond there. The CAD strength seen in June has been helped by general USD weakness but also a very substantial speculative short CAD position in the futures market. However, this had already been reduced by half from its highs by June 27, and further reductions are likely to have been seen by the end of the month. While a rate hike would likely maintain the CAD uptrend, yield spreads with the US don’t suggest major scope for further CAD gains from here. If the BoC were to disappoint, there would be initial scope back to the 1.32/1.33 area, but since this would likely be perceived as a delay rather than a cancellation of a hike, further gains would be hard to achieve.

June USD/CAD Performance:

While USD/MXN fell further in June, in line with the generally weaker USD, USD/MXN struggled to break convincingly below 18.00 and will likely continue to struggle there unless there is some clear positive news on the US trade front. Unlike the EUR, CAD and GBP the MXN is unlikely to benefit from monetary policy news, and the risks may now be on the upside for USD/MXN, especially if the Fed indicates potential for further tightening this year at the July 26 FOMC.

June USD/MXN Performance: