DB FX Daily: Canada CPI, Short-term Shift in G3 Spread Trends

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FX Daily: Canada CPI, Short-term Shift in G3 Spread Trends

Canada CPI and CAD

In the most recent Dollar Bloc Weekly our strategists argued that for the rates market to consider the prospect of hikes in Canada in 2007, a shift to a tightening bias from the Bank of Canada may be necessary for which another above consensus inflation print would likely be key. Today's Canada CPI release is therefore a potentially important driver for USD/CAD as a shift to pricing in rate hikes could potentially extend a CAD rally which has so far been built on a cut to short CAD positions, improvement in commodity prices and the removal of the rate cuts which had previously been priced in. The link between the yield on BAX contracts and USD/CAD (note not the rate spread) is shown in the chart at left below. A lower inflation number could however stall the recent CAD rally given short CAD positions have now been pared back and the flat profile of the BAX strip offers little of interest unless a shift towards tightening is considered by the markets.

Some Short-Term Signs of Fatigue in Spread Trends?

The DB FX Theme Radar published separately this morning continues to show a strong link between rates and FX moves. The past few days have seen some of the recent trends in rate spreads between the US, Eurozone and Japan either level off or correct. The sharpest moves have perhaps been seen in 2Y US-Japan and 2Y Eurozone-Japan spreads which have tightened after nearly a month of steady spread widening and has perhaps aided the rebound in the yen over the past two trading days. As for Eurozone-US spreads 2Y nominal rate differentials have stabilized around -60 bps while 10Y real differentials have pulled back some 10 bps after steadily narrowing in 2007. These changes in the trajectory of spreads are not large enough yet to disrupt the recent trends of USD weakness and JPY underperformance but may have been sufficient to aid some consolidation in the weak USD trend and the bounce in the JPY. Given the tight links between rates and FX over the recent past these very recent developments in spreads bear monitoring going forward in case the most recent trajectory continues.