Dollar dips after hitting fresh 1-year highs yesterday, CPI data in focus

GBP

Sterling starts this morning's session 0.18% higher against the US dollar as it looks to post gains over the course of the session for the first time in four trading days. After multiple false starts, GBP traders are beginning to wonder what needs to change for the pound to close the day out higher. Hawkish Bank of England pricing has recently weighed on the pound as interest rate hikes are now expected to come at a time where the macroeconomic backdrop is weak, while even some positive notes in yesterday's labour market data failed to help the pound consolidate early gains. This morning, with the US dollar trading on the back foot and global back-end yields seemingly tumbling, it looks like today may be GBP's best shot of closing the session out in the green. The rally comes amid growth data that has undershot expectations for August with a 0.4% MoM print coming just 10bps shy of expectations. Economic growth has now undershot the Bank of England's 2.1% QoQ forecast for Q3, with just September's reading to go. This highlights the sluggish activity conditions behind the inflationary overshoot, which may cool concerns among policymakers and reduce the possibility of imminent rate hikes. For the rest of the day, BoE member Cunliffe speaks at 14:30 at the SWIFT conference, while Treasury Secretary Sunak heads up a G7 meeting of finance ministers in Washington today and is expected to discuss how to make supply chains more resilient.

EUR

The euro moved all the way down to a fifteen-month low against the US dollar in yesterday's session, and while yesterday's data docket included a big miss in ZEW economic sentiment data, the lows were unrelated to the data as indicated by the timing of the moves. Instead, it was moved from bond markets that ignited the fresh lows as the euro remains sensitive to changes in US yields given rate differentials between the US and eurozone. Despite betting markets now pricing in a rate hike by the European Central Bank by December 2022, ECB members continue to highlight the subdued inflation outlook over the medium term. After Chief Economist Philip Lane commented on the inflation outlook on Monday, Governing Council member Francois Villeroy de Galhau added yesterday that the outlook warrants continued monetary support, and the asset purchase programme (APP) could benefit from more dexterity as inflation is still likely to fall short of the 2% target in the medium term. As the ECB focuses firmly on keeping financing conditions favourable, a new programme to complement APP or significant changes to APP past March 2022, when the pandemic purchases expire, is likely.

USD

As cautioned in yesterday's morning report, developments in US fixed income instruments dominated market price action yesterday as bond traders caught up following US markets being closed on Monday. Rising front-end yields spurred the dollar on, with the DXY index carving fresh 1-year highs at 94.561 as yield sensitive currencies like EUR and JPY plumbed fresh lows against the greenback. With front-end Treasury yields still off yesterday's highs, the dollar is retracing at the margin. However, with US CPI data due out at 13:30 BST, any signs of continued inflationary pressure are likely to be met with even higher yields driven by rising breakeven rates. Expectations sit at 5.3% for the headline reading in September, however, risks are tilted slightly to the upside given the recent price rises in energy and commodities. It may be too soon for these price increases to fully filter into the headline reading, and even more so for second-round effects to impact the core measure which is projected to hold stable at 4%, but the risk remains nonetheless. Any signs that inflation pressures are starting to cool is likely to be met with a sigh of relief from some corners of markets.

CAD

The Canadian dollar has traded in an extremely tight range thus far this week. With limited data released and rising commodity prices helping the loonie offset broad USD strength, the backdrop remains supportive of limited volatility for now. Today's US CPI data may help the pair break out of its 0.52% trading, however, as oil prices have seemingly consolidated around the $80 per barrel mark, while US front-end yields may have further to climb on the data release. Broad USD strength could pressure the Canadian dollar in lieu of any other idiosyncratic USDCAD drivers. On the topic of inflation, discussions around the Bank of Canada's mandate continue as the recently re-elected Trudeau government is expected to renew the central bank's targets before year-end. A poll conducted by Nanos Research Group for Bloomberg News found that only a third of Canadians said they were comfortable with the idea of raising the central bank's inflation target, following a sustained overshoot thus far this year. Meanwhile, 56% said they were uncomfortable and would instead prefer for the current 2% target with a 1-3% band to be extended for another 5 years. With the Bank of Canada set to complete its QE taper in the coming months and then eye interest rate rises, any adjustments to the mandate will be key for monetary policy expectations.