US
Financial market risk sentiment turns sour on renewed concerns over the Strait of Hormuz naval blockade. The US Navy seized an Iranian ship in the Gulf of Oman and Iran vowed to retaliate soon. Brent crude oil prices are nearly $10 higher from Friday’s $86 a barrel low. Stock and bond markets are down, while USD is a little firmer. Energy-sensitive NOK leads G10 FX performance, extending a trend in place since the war began on February 28.
We are sticking to our view that while the energy shock may not be over, the worst is probably behind us. The US “Open for All or Closed to All” approach to navigation for vessels transiting the Strait of Hormuz is more likely to accelerate a reopening of that crucial waterway because shared economic pain raises the incentives for all parties to reach a workable diplomatic off-ramp. As such, interest rate differentials between the US and other major economies should continue to keep the DXY (USD index) anchored within its nearly one-year 96.00-100.00 range.
The Wall Street Journal reported that the United Arab Emirates (UAE) is exploring the possibility of securing a currency swap line from the Fed or Treasury to hedge against a more severe economic shock from the Iran war. The fact that a well-capitalized energy exporting country is entertaining the idea of a bilateral currency swap line with the US underscores the dollar’s dominant role in the global financial system as medium of exchange and unit of account.
CANADA
USD/CAD is directionless around 1.3700. Canada March CPI is up next (1:30pm London, 8:30am New York). Headline CPI is seen at 2.6% y/y vs. 1.8% in February due to the jump in energy prices. Excluding food and energy, the rise in CPI is expected to be more muted at 2.2% y/y vs. 2.0% in February, while the policy-relevant core CPI (average of trim and median) is projected at 2.3% y/y vs. 2.3% in February.
Later today, the Bank of Canada’s (BOC) Q1 Business Outlook Survey (4:30pm London, 11:30am New York) will offer a read on how well long-term inflation expectations are anchored.
The swaps curve has trimmed BOC rate hike bets over the next twelve months from as much as 75bps on March 26 to 40bps currently. BOC rate hike bets should ease further provided underlying inflation and long-term inflation expectations remain contained. Canada’s economy is operating below full capacity with a negative output gap between -1.5% and -0.5% of potential GDP.
Bottom line: USD/CAD will likely trade within a 1.3500 and 1.3800 range in the near term. On the crosses, long CAD is a good hedge against a more persistent energy price shock. Canada gets the terms of trade boost and has fiscal space to absorb some of the growth drag to domestic demand.
