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Talking Points:

- Fed March rate hike odds remain at 100%, and we’re starting to see rate expectations for the rest of 2018 pickup after Fed Chair Jerome Powell’s testimonies this week.

- Rates markets have started to downgrade the odds of a rate hike by either the BOC or the BOE in May, both odds remain above 60% for both central banks.

- See the full DailyFX Webinar Calendar for other upcoming strategy sessions.

Upcoming Webinars for Week of March 4 to 9, 2018

Monday at 7:30 EST/12:30 GMT: FX Week Ahead: Strategy for Major Event Risk

Wednesday at 6:00 EST/11:00 GMT: Mid-week Trading Q&A

Thursday at 7:30 EST/12:30 GMT: Central Bank Weekly

Looking to learn more about how central banks impact FX markets? Check out the DailyFX Trading Guides.

FOMC March Hike Odds Hold at 100%; June Odds Edge Higher

Rate hike odds for the Federal Reserve's March meeting remain at 100%, so we’ve turned our attention further down the glide path to see what market participants think. Even as the odds of the second (June) and third rate hikes (by November) in 2018 have been pulled higher in recent days – no doubt due to the perceived hawkish commentary from new Fed Chair Jerome Powell – the US Dollar still doesn’t seem that motivated to rally.

It’s worth repeating that this may be evidence of a 'regime change' taking place in financial markets. Whatever the true reason may be, the fact is that traders are no longer looking at a more aggressive rate hike path from the Fed as a de facto positive for the greenback.

Chart 1: DXY Index versus June FOMC Rate Hike Odds (October 2017 to February 2018)

Central Bank Weekly: Fed Rate Hike Odds Increase; BOC, BOE May Odds Drop

In 2018, the US Dollar has shrugged off the climb in hike odds, although the relationship has become less negative in recent weeks. With June rate hike odds hitting 66% today, the 20-day correlation with the DXY Index has increased to -0.03. On January 30, the 20-day correlation between the DXY and a second hike in June was -0.82.

BOE May Hike Odds Stay Above 60% Before Brexit Headlines Return

Last month, the Bank of England's Quarterly Inflation Report allowed for policymakers to begin talking up the possibility of a rate hike coming in the first half of 2018. Despite the fact that British Pound is up year-over-year against a basket of major currencies, inflation remains stubbornly high near +3%, and BOE officials believe that price pressures could remain elevated given the backdrop of rising energy prices.

Chart 2: GBP/USD Spot versus May BOE Rate Hike Odds (October 2017 to February 2018)

Central Bank Weekly: Fed Rate Hike Odds Increase; BOC, BOE May Odds Drop

Even though there is no significant correlation between hike odds and GBP/USD (20-day is -0.41), it appears that the Sterling priced in the jump in probability early: the 20-day correlation, factoring in a two-week lag in hike expectations, rises to +0.12. In our last update, it is worth noting that the two-week lag 20-day correlation was +0.52, suggesting that the BOE is having less of an influence. Current May hike odds sit at 62%.

Thus, while the focus for traders should remain on economic data developments in the near-term, Brexit headlines are likely to reassert themselves now that the negotiations will be in earnest later this month. Evidence that inflation readings will stay elevated over the next three-months should keep May rate hike odds pointing higher, supporting Pound Sterling, but negative Brexit developments could neutralize this influence.

Blame May BOC Hike Odds for the Weakening Canadian Dollar

Chart 3: CAD/USD Spot versus May BOC Rate Hike Odds (September 2017 to February 2018)

Central Bank Weekly: Fed Rate Hike Odds Increase; BOC, BOE May Odds Drop

The Canadian Dollar has been depreciating essentially non-stop over the past six-weeks, and there is no need to look any further than what’s been happening with Bank of Canada rate hike expectations for the first half of 2018. Since mid-January, the odds of a May rate hike (there is no BOC meeting in June) have fallen from 80% down to 65% today. The current 20-day correlation between CAD/USD and May BOC hike odds is currently +0.73.

Read more: US Dollar Posture Continues to Improve; PCE Core, Powell Due Up

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

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