USDCAD – 7 June 2023

The recent USD rally up to 31 May comes as investor optimism gathers momentum following the Biden-McCarthy deal averting the prospect of a technical default in the States. Crucially the Fiscal Responsibility Act suspends the debt ceiling through to 1 Jan 2025 – giving the US some breathing space as their debt obligations continue to soar and federal debt exceeds $31.47tn. While the fiscal tightening measures aim to reduces the government deficit by some $1.5T over next 10 years, the deal keeps intact much of Biden’s landmark Inflation Reduction Act which seeks to reduce inflationary pressures and mitigate against the prospect of a recession. Hence, while uncertainty around debt-ceiling discussions propagated a general risk-off sentiment, the passing of the Fiscal Responsibility Act has buoyed investor sentiment feeding into dollar strength.

Dollar strength has also come as a result of markets upward revising their rate hike expectations from the Federal Reserve. The release of the minutes from May’s meeting suggests while several of the FOMC may be inclined to ‘skip’ a rate hike in June, given that “many participants focused on the need to retain optionality after this meeting”, the possibility of further rate hikes remains. While markets in early January were pricing in a terminal rate of 5% (by June 2023), persistent inflation has seen this upwardly revised. For example, money markets are now pricing in 75% chance of rates hitting 5.5% by 26 July, with such revisions feeding into further dollar strength. Given the minutes’ emphasis on policy makers retaining optionality, much of this recent upward revision in rate expectations have been the result of fresh data pointing to further inflationary pressures.

With markets weighing on FOMC members’ policy inclinations being heavily data-dependent, recent economic indicators pointing to persistent inflationary pressures has seen markets rally towards the dollar. For example, on 1 June, the ADP Employment Change surpassed expectations of 170,000 having hit 278,000. Along with non-farms similarly beating forecasts (339,000 vs 170,000), markets assessed the impact that a persistently tight labour market would have on inflation and in turn, the FOMC’s appetite for a further rate hike. Notwithstanding marginally higher-than-expected unemployment and slightly softer wage-growth the DXY dollar index rallied 0.75% in the 12 hours following the US labour market print, as markets weighed on the possibility of a further hike.

The US labour market print came just a week after stronger-than-expected US Q1 GDP results (1.3% vs 1.1%), saw investors further rally towards the dollar. Here, consumer spending rose greater than forecasted, though investor sentiment remains cautious given that the print still marked the weakest growth since Q2 2022, and consumer confidence slipped in April and May.

While US labour data saw markets upwardly revise rate hike expectations from the Fed, the ensuing DXY appreciation was countered by rising oil prices which fed into considerable CAD strength. As such with WTI crude futures rising 7.4% between 1 and 5 June, USDCAD slipped over 1%.