DXY Index Working On Second Inside Day Amid Central Bank Activity

After a sharp drop on Monday to start the week, the US Dollar (via the DXY Index) has found some reprieve the past two days, first posting an inside day on Tuesday, followed up by what has been another inside day effort on Wednesday so far. Coming at a time when price is at critical range support dating back to mid-October, the dual inside days speak to an underlying state of uncertainty among traders presently.

Fortunately, the coming 48-hours are saturated with central bank activity, superseding any economic data due out on either Wednesday or Thursday. While the Bank of Canada’s rate decision will be the only activity with any direct implication on where rates go, both the Bank of England and the Federal Reserve will see their top policymakers speak, which always carries significant risk.

BANK OF CANADA TO KEEP RATES ON HOLD

With the oil industry accounting for nearly 11% of the Canadian economy, the sharp drop in oil prices since the start of Q4’18 has had a materially negative impact on rate expectations: weaker oil prices translate directly to slower growth, which undermines a hawkish BOC. Accordingly, rate hike odds for today’s January BOC meeting have dropped from 85% on November 2, 2018, to 0% entering this week, with a 21% chance of a 25-bps rate cut.

Over the next few months, overnight index swaps see rate cut odds subsiding back to 0%, and as it stands, rates markets aren’t pricing in greater than a 25% chance of a rate cut or hike at any point through June 2019. We’re expecting the BOC to signal that it’s firmly in a neutral policy stance, with the implicit understanding that energy prices will determine the next policy move.

BOE’S CARNEY HAS A CHANCE TO MAKE SOME NEWS

To the BOE’s credit, they have followed through on their promise to keep monetary policy on hold in the run-up to the March 2019 withdrawal deadline. But amid a sharp plunge in energy prices since the start of October, UK inflation expectations have started to slump, largely in line with declines experienced by both EU and US inflation expectations. As such, with both Fed and ECB policymakers suggesting that policy normalization could be put on pause in light of recent data, now would be the appropriate time for BOE Governor Mark Carney to join the chorus without risking looking like he’s trying to put his finger on the Brexit scale.

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