DB FX Daily: Focus shifts to central banks, CAD support from US data

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FX Dail: Focus shifts to central banks, CAD support from US data

US data surprises continue, but focus likely to shift to central banks over the week ahead

The US data flow continues to surprise on the upside, with payrolls and the ISM printing above expectations and overwhelming a better than expected reading on the core PCE deflator. The US data saw a sizeable sell off in the body of the Eurodollar strip, with Fed Funds at the time of writing pricing only a 15% probability of a 25 bp easing by the end of the year. EUR/USD managed to perform well in the face of the strong activity data and a low PCE print - a combination that should have been quite USD supportive.

USD/JPY, however, moved higher through the session driven by the combination of strength in the US data (see the first chart below for the 20 day correlation between USD/JPY and the respective 2 year rate differential) and a continuation of the low volatility environment in FX markets. (See Friday's FX daily for a chart on USD/JPY and the DB currency volatility index.)

Central banks take centre stage over the week ahead with rates announcements from the ECB (25 bp hike expected by DB and the market); the BoE (we and the market look for no change in rates, although there is about 5 bps of tightening priced in); the RBA (no move expected by DB or the market) and the RBNZ (also no move expected by us or the market).

CAD finds support in strong US data

USD/CAD continued to move lower in Friday's New York session, helped by the combination of higher oil prices and stronger than expected US data. As the chart on the right shows, strong conditions in the US economy (with the broad US economic cycle represented in the chart by the ISM) tend to push USD/CAD lower. In our view the very strong trade and economic links between the US and Canadian economies, amplified by Canada's heavy exposure to the commodities cycle explains this tendency.

While we retain our view that USD/CAD could test 1.05, the risk now appears to be that this occurs in the coming days and weeks as opposed to the coming months. The key risk event in Canada over the week ahead will be the May labour force data (due on Friday) where we are looking for a slightly above market print on employment, with the unemployment rate expected by us to tick down to 6.0%.