The Federal Reserve and Bank of Canada monetary policy announcements on Wednesday are the biggest events on this week’s calendar. After Monday’s big moves, the US and Canadian dollars fell into tight trading ranges. This contrasts with stocks which posted strong sell-off in Asia and resumed their slide during the New York session prior to the Fed’s announcement. Wild stock market volatility is a sign that investors are nervous about the aggressive stance of stocks. two central banks tomorrow.
It is widely expected that the Federal Reserve will announce a rate hike in March, which would trigger a series of tightening measures. The latest stock market swings have lowered expectations of a 50bp hike at the next meeting, but a 25bp hike is certainly on the way, with a full 100bp base tightening forecast in 2022. The latest consolidation of the US dollar confirms these expectations, which means that for the greenback to extend its gains, the Fed has to be very aggressive.
With inflation rising at the fastest pace since December 1982, Federal Reserve Chairman Jerome Powell has no choice but to initiate the first central bank rate hike since 2015. Continuing supply chain shortages and continuing strength in commodity prices mean that inflation could remain uncomfortably high for a long time without a sufficient policy response. The Fed hoped that weaker demand would slow growth as there are signs everywhere that the recovery is stabilizing, but it is not and it cannot afford to wait any longer.
The question that now arises is that of the roadmap.
If Powell confirms that rate hikes will begin in March and suggests the Fed should aggressively control inflation with more than four tightening cycles, the US dollar should rise against all major currencies. However, anything that goes wrong could trigger a rally in stocks and currencies that reduces the demand for US dollars. Powell might suggest that inflation could normalize quickly after a few rounds of tightening. He might also point out that further increases depend on economic performance. Mr Powell could also argue that the authorities are not engaging in any tightening cycle, but that is unlikely.
The real question is: how much will inflation drop in response to the first tightening measures? And will it be enough? If the Fed thinks the decline could be rapid and significant, its leadership could be less belligerent. On the other hand, if he thinks that aggressive efforts will be needed to alter price movements, a sharply hawkish stance may be justified. Central bank management will not only determine how currencies and stocks move after the FOMC, but also for the rest of the week.
Canadian dollar traders will also attend the Bank of Canada monetary policy meeting. The BoC makes its announcement tomorrow before the Fed and the volatility of the CAD is assured. Most economists are not expecting a rate hike this month, but the market is pricing in a 75% probability of a quarter point. The Canadian dollar is trading higher before the rate decision. Although many Canadian provinces reintroduced restrictions during the latest wave of COVID-19, the labor market is strong and inflation is high. In particular, employment is at an all-time high and prices are rising at the fastest pace in the past three decades.
The Bank of Canada was one of the first central banks to cut stimulus during the pandemic and, with the positive performance of the economy, could surprise with a rate hike. If the BoC were to take the plunge and raise interest rates, it could turn back towards 1.25, although with the Fed meeting a few hours later, the loonie should move mostly against,, or. If the Bank of Canada makes no deliveries and leaves interest rates unchanged, investors will try to sell Canadian dollars.