Market Brief: Currencies Trade Mixed Ahead of Inflation Print

Currency markets are struggling against dangerous cross currents this morning as traders grapple with the impact Donald Trump’s policies might have on inflation, capital costs, and global trade. In a series of announcements published over the last two days, the president-elect appointed a number of loyalists to key positions, suggesting that he intends to follow through on campaign pledges that could raise prices, force the Federal Reserve to ease more slowly, and hammer trade-dependent economies outside the United States. Yields are pushing higher, equity futures are setting up for a weaker open, and the greenback is trading on a mixed basis against most of its rivals.

Against that backdrop, the Canadian dollar looks poised on the edge of breaking through post-pandemic lows to the downside. With trade threats on the horizon and expectations for the Federal Reserve and Bank of Canada diverging to levels not seen since the late nineties, a US inflation surprise could kick the exchange rate through the 1.40 threshold against the greenback for the first time since early 2020 - a move that could clear the way for a two-to-three percent drop. But the loonie also remains a relative outperformer in a global context, having lost less than any of its major rivals since polling closed in last week’s US election. This may reflect subtleties in the trade relationship - Canada’s biggest exports (energy and autos) seem likely to receive tariff exemptions, and the country often runs a net deficit - but might also have something to do with the fact that the economy is so closely tied to the US. Traders may be imagining a parallel to the “if the US sneezes, Canada catches cold” dynamic: if the US gets stronger, Canada could see some corollary benefits.

Japan’s yen is on the defensive after breaking through the 155 threshold against the dollar for the first time since July. A ramp in US yields has taken a toll on cross-Pacific rate differentials, overwhelming relative hawkishness in Japanese policy circles. A near-50 percent likelihood of another rate hike at the Bank of Japan’s December meeting hasn’t turned the tide, and further weakness looks like a strong possibility - but with intervention fears returning, losses are likely to proceed slowly.

The Chinese yuan is trading on a modestly stronger footing, supported by the central bank’s guidance. The People’s Bank of China set its fixing rate - the reference rate around which the currency is permitted to oscillate - more than 400 points higher than expected last night, suggesting that policymakers are working to stem losses ahead of an expected escalation in the country’s trade war with the United States. We think authorities will stage-manage the currency’s decline ahead. With the threat of a resurgence in capital outflows preventing the mechanical depreciation that might otherwise result from a dramatic increase in tariffs.

The ‘Trump trade’ might gain added momentum this morning. The October consumer price index release will be distorted by hurricane-related effects, and should ultimately find itself overshadowed by the November non-farm payrolls report in influencing Fed policy, but could nonetheless exacerbate market concerns over the direction of inflation. With breakevens signalling a sharp jump in market-implied price expectations, and ten-year Treasury yields already flirting with the 4.5-percent threshold, an unexpectedly-hot print could lower odds on a December rate cut and trigger a violent response from trigger-happy traders, kicking the dollar higher.

But currency markets look close to dangerously oversimplifying the economic outlook. Major uncertainties exist with regard to the composition, sequencing and magnitude of the policy changes that are likely to come under the new Republican administration. It is difficult - if not impossible - to model the ways in which higher tariffs, more government spending, restrictions on immigrant labour supply, and a reset in US foreign policy might interact with existing conditions to drive growth and inflation outcomes across major economies.

Forecasters at the world’s biggest banks are aligned in expecting further dollar strength, with US economic exceptionalism, high yields, strong equity market returns, and safe haven characteristics seen supporting a sustained rally. The greenback certainly looks unstoppable at the moment. But a peak could come sooner than anticipated (perhaps even before the end of the year), and we would caution corporate hedgers against assuming that the ‘Trump trade’ will continue to favour the dollar beyond January - a quick glance at how forecasts for this year have panned out should make it clear that foreign exchange markets tend to defy consensus expectations.

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