US inflation, ECB and USD risks before the elections


Dollar to stay firm this week as event risks may inject some volatility It’s an action-packed US calendar this week: inflation data, Fed talk, the third US presidential debate and the 3Q16 earnings season are all sources of volatility for global markets. With oil base effects starting to rapidly filter out, the Sep US CPI data will once again show headline inflation converging towards 2% –putting the Fed’s inflation target within touching distance. While some Fed officials attributed the strong underlying inflationary trends to a few sub-components (medical costs and rents), the resilience in core inflation around 2.3% YoY is becoming hard for bond markets to ignore. On Friday, Chair Yellen hinted at a need to temporarily run a “high-pressure economy” in order to eradicate the hysteresis effects linked to the post-GFC recession. A willingness to keep short-term rates low and allow the economy to overheat would see a bearish steepening of the US yield curve – which could spell trouble for global risk assets. The final US presidential debate takes place on Weds and while odds of a Trump win have faltered, in the words of Secretary Clinton we shouldn’t “think that this election is over” just yet.

ECB to allay fears that it has run out of ammo; EUR/$ could test 1.09 All eyes will be on President Draghi this week, with markets largely expecting the ECB chief to pour cold water over the recent QE taper hype. Thursday’s meeting will be too early for any material tinkering to the current asset purchase programme, though Mr. Draghi may have to lift the veil a bit and reaffirm scope for an extension of QE beyond March 2017 in order to allay fears that the central bank has run out of bond-buying ammunition. While it is difficult to see the ECB telling us anything new to drive Bund yields and the EUR sharply lower this week, we note that the EZ still remains at best a 1% inflation economy – around half of what the US economy is running at. Signs of further divergence will keep EUR/$ downside in play ahead of the ECB; look for a move to 1.09.

Stay long $/CAD (target 1.35) given catalysts for a topside breakout The domestic highlight of the week will be the BoC policy decision (Weds); we’re expecting no change in policy, but downside risks to the GDP and CPI profiles – as well as renewed concerns over the output gap – should give rise to an overall dovish BoC tone. While we accept that the bar for additional easing is high given the proximity to the ZLB, we feel that markets may be underestimating scope for a 1Q17 rate cut (<10% probability priced in). Lower CAD rates, as well as softer crude prices and US election risks, are all reasons to expect a USD/CAD topside breakout this week; a breach of the 1.33 resistance could see a rally up to 1.35.