Oil price concerns the focus at Fed meeting – don’t expect any strong signal

USD: Fed to keep options open given uncertainties

The US dollar has weakened back marginally with EUR/USD rebounding a little over 1% from the intra-day low on Monday and crude oil prices down about USD 5 p/bl from the high at the open on Monday. There has been no let-up in hostilities and indeed the killing of Iran’s security chief Ali Larijani could well see Iran spurn any attempts over the near-term for a ceasefire. But again yesterday President Trump stated that the war in Iran would be over “soon” and this consistent message from Trump is for now helping to contain the move in energy prices. That in turn has eased the positive momentum for the dollar. The resilience of equity markets also helps contain FX moves as well. The S&P 500 is down just 2.4% since the war started and yesterday closed higher for the second consecutive day. Asian markets are all higher today.

The FOMC will meet this evening and the focus will very much be on the potential implications on inflation stemming from the conflict in the Middle East. This FOMC meeting will also see the Summary of Economic Projections released and the SEPs will likely see limited changes which will help Fed Chair Powell in his messaging that it is too soon to make any conclusions over the impact of the war. The obvious statement he will make is that the longer the conflict lasts the greater the upside risks to energy prices and hence inflation will be. We therefore do not expect the FOMC to alter the median dot profile which in December revealed a profile of one rate cut in 2026 and one in 2027. Powell will likely emphasise the fact that conditions now are very different to the last energy price shock in 2022 and that on this occasion the FOMC will have a little more time to assess the backdrop. The monetary stance is one big difference that Powell could highlight with the stance today still restrictive unlike in 2022. There will be no pent-up demand driving growth going forward unlike in 2022-23.

That said we would also argue that given the errors of 2022-23 for global central banks in general, including the Fed, Powell will likely also highlight the risks and that the Fed will be mindful to the risks of energy price rises seeping into food and services that could then shape wage growth and complicate the medium-term price stability goal. But these will all be merely scenarios at this stage and we suspect a balanced communication with no strong signals on guidance until there has been a bit more time to assess the potential longevity of the conflict.

The US dollar is around 2% stronger since the conflict began with EUR/USD down 2.3% with about 35bps of rate cuts removed from market pricing since the conflict began. We would be surprised to see any big rates or FX moves this evening given the likelihood of a balanced communication with no strong signals. As can be seen above, FX is currently not being driven by relative rate expectations with the above correlation at its weakest since the covid period in 2020-21. A similar chart indicating the DXY / crude oil correlation has seen a sharp strengthening of the US dollar / crude oil correlation. So with all eyes on the newsflow from the Middle East and energy prices, we do not expect much in the way of rates and FX volatility following the FOMC meeting.

3MTH AVG OF 30-DAY ROLLING DAILY CORRELATION – DXY VS 2YR SPREAD

Source: Bloomberg, Macrobond & MUFG GMR

CAD: BoC set to hold as CAD remains resilient

In addition to the FOMC meeting this evening, the Bank of Canada meets and will announce its monetary policy decision at 13:45 GMT. The decision takes place today against a backdrop that has of course changed notably and hence we’d expect a cautious message by the BoC as well that will likely emphasise the high level of uncertainty and hence the need for additional time in order to assess the extent of the potential inflation impact from higher energy prices. The Canadian dollar is currently the top performing G10 currency after the US dollar since the conflict began and has weakened just 0.3% against the US dollar, helped by the positive terms of trade shock being a crude oil producer. The Australian dollar, another energy producer is the next best performing G10 currency, down just 0.7% versus the US dollar.

Whether that CAD performance can persist is questionable. The BoC meeting today follows a terrible employment report with jobs declining by 84k in February, driven by a 108k drop in full-time employment. It was the largest drop since the plunge in jobs in April 2020 following the start of covid. In addition to that, the latest CPI data was weaker than expected with headline YoY CPI falling 0.5ppt to 1.8%, the lowest since July last year. Certainly this most recent flow of economic data points to the BoC having time to assess any upside inflation risks stemming from the conflict.

Ahead of the conflict the market was pricing a mere 3bp risk of a cut at the March meeting but by year-end had a 11bps of easing priced. March is now close to zero basis points priced and by year-end one 25bp rate hike is priced. Given the plunge in jobs and weaker CPI since then, the market would certainly have been potentially close to a 25bp cut priced by year-end were it not for the conflict. Tariff uncertainties have hit trade with the US and weak jobs data in the US also points to downside risks to Canada growth due to US growth risks. We continue to assume the Trump administration will engineer and off-ramp to de-escalate within the next two weeks and hence we would assume the BoC could still be in a position to cut by year-end. But the message today will be clear – the BoC needs time to assess the possible extent of the energy price shock before making any conclusions on the direction of the policy path.

In that scenario, USD/CAD should remain in a relatively tight trading range and initially if the conflict was to last longer and crude oil prices were to jump further beyond the USD 100-level then CAD support from the terms of trade dynamic could start to fade if North America growth risks increase and equity markets take a hit. Risk-off would start to play a greater role that would see USD/CAD move to the upside. For now that is not our base case and while we remain in the relatively early stages of this conflict, we expect the BoC to steer clear of any clear guidance on the policy outlook.

USD/CAD TRADING IN LINE WITH CURRENT US-CA 2YR SWAP SPREAD

Source: Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com