• Thursday’s US CPI volatility leaves USD/CAD higher.
• Russia’s threat to Ukraine helps the US dollar on Friday.
• Federal Reserve rate intentions complicated by inflation, Russia.
• FXStreet Forecast Poll predicts near-term gains for USD/CAD.

Volatility surrounding the US inflation report on Thursday and the sharp hike in Treasury rates gave the US dollar its biggest boost this week, with reported Russian threats against Ukraine adding a boost on Friday . Even so, USD/CAD finished at 1.2745, below its Monday open of 1.2754.

U.S. consumer inflation jumped to 7.5% in January, a four-decade high, sending stock and bond prices plummeting and raising the steepness of the Treasury yield curve. The 10-year Treasury yield climbed 24 basis points on the day, closing at 2.035%, the first finish above 2% since July 2019. All Treasuries except the 30-year, ended the day with returns above their level in March 2020. before the start of the pandemic.

Treasury yields fell on Friday afternoon as reports surfaced that the UK had advised citizens to leave Ukraine and was evacuating embassy staff from Kyiv. Biden administration officials told the Public Broadcasting System (PBS) that the United States expects a Russian invasion of Ukraine next week.

The 10-year US Treasury yield fell 11 basis points to 1.918% as bonds rallied on security concerns. The Canadian equivalent yield fell 7 points to 1.871% after the Russian news.

Even with Friday’s retreat, the yield spread between the US 1-year Treasury note and its Canadian counterpart, with Canada not having a 2-year note, has narrowed significantly this year. At the close on December 31, the US 1-year was paying 0.389% and the Canadian 0.780%, for a Canadian advantage of 39 basis points. By the end of Friday, the US note was yielding 1.037% and Canada’s 1.19%, a 15 basis point advantage.

The shares fell after the various Russian reports. The Dow Jones ended down 1.43%, 503.53 points at 34,738.06. The NASDAQ lost 2.78%, 394.49 points to 13,791.15 and the S&P 500 lost 85.44 points, 1.90% to 4,418.64.

The greenback’s late gains on Thursday were also helped by comments from St. Louis Federal Reserve Chairman James Bullard, a well-known inflation hawk. He said the bank should raise the federal funds rate by 100 basis points by July. This would imply at least a 0.5% increase over the three FOMC meetings of March 16, May 4 and June 15.

Prior to Thursday’s CPI data debate, the market had focused on whether the Fed would hike 0.5% at the March 16 meeting. The general opinion was no.

On Wednesday evening, the probability of a 0.5% increase next month was put at 24% by the Chicago Mercantile Exchange (CME) FedWatch Tool, which uses Fed futures to calculate odds.

CME

Immediately after the inflation figures on Thursday, the probability had risen to 92.8%.

The rating fell back to 44.3% at Friday’s close.

Federal Reserve Chairman Jerome Powell said the bank would start shrinking its $9 trillion balance sheet, acquired over the past decade, after bond purchases ended in March. Until Thursday, the assumption was that the bank would wait a month or more after the termination before starting a portfolio reduction.

A passive roll-off, where the Fed does not reinvest the proceeds of maturing securities, has been expected for several months. If Mr. Powell announces the date at the March FOMC meeting, it will come as no surprise. Its advent and its composition will be the main subject of questions from journalists. A much more aggressive choice would be active selling. This would send a powerful rate signal to credit markets, guaranteeing much higher Treasury and commercial rates.

For now, a stronger Fed response appears to be avoided by the threat to global and US growth posed by a Russian invasion of Ukraine. Although diplomatic responses and sanctions may vary from country to country, a virtual guarantee is that oil and energy prices would skyrocket.

The 3.6% jump in the price of West Texas Intermediate (WTI) on Friday is a direct result of the Ukrainian situation. If a conflict were to break out, the euro would be particularly vulnerable. Germany, the largest economy in the united currency, gets around 30% of its energy from Russia, which would be under threat.

Canadian data this week was limited to December imports and exports and had no impact on the market.

In the United States, jobless claims fell to 223,000 in the week of February 4, the fourth consecutive decline and the lowest total in five weeks.

Michigan’s Consumer Confidence Index for February unexpectedly fell to 61.7, its lowest score in more than a decade, from 67.2 and underscores the risk to the US economy if consumers were to cut their expenses. It had been expected to rise to 67.5.

USD/CAD Outlook

USD/CAD will be subject to the countervailing forces of rising US interest rates, potentially higher crude prices and a US dollar safety trade, if Ukraine flares up.

It all depends on what Vladimir Putin in Moscow decides. If Russia begins a military operation, WTI will soar, at least initially, taking the Loonie with it, and USD/CAD lower. Alternative oil producers in OPEC, Nigeria, Indonesia and elsewhere are unable, and would not be willing, to increase production to replace Russian crude. China would benefit as it would become Russia’s largest customer and gain pricing power. Shale producers in the United States have been crippled by the Biden administration’s energy policies that should be credibly reversed, to bring production back to 2019 and 2020 levels.

A Russian invasion of Ukraine, even limited to the eastern region of Donbass, would dominate politics and financial markets. Treasury rates would fall as markets sought the safety of US bonds. The likelihood of the Fed implementing a more aggressive rate program during a Russian invasion of Ukraine is nil.

There are many unknowns in the outlook for USD/CAD in the event of a Russian invasion. The strength of the security trade with the US dollar depends on the objectives and violence of an invasion and the Western response. Initially, the surprise would play on US assets, the dollar, treasury bills and USD/CAD. The longer-term vision would be dictated by the evolution of the oil market and the political and military situation in Ukraine.

With these possibilities weighing on the USD/CAD, traders should expect a neutral outlook as the politics of the former Soviet and Czarist empires unfold.

Canadian inflation in January should follow that of the United States, but increase. December retail sales are expected to improve.

Retail sales are the most relevant US data. Sales stagnated in the fourth quarter. If the expected 1.6% rise does not materialize, concerns about the US economy will spread to the all-important consumer sector. Weak selling could drive down Treasury rates and the outlook for a Fed rate hike.

Statistics Canada February 7 to February 11

FXStreet

US statistics from February 7 to February 11

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Statistics Canada February 14 to February 18

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US statistics from February 14 to February 18

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USDCAD Technical Outlook

Movement over the past 12 USD/CAD sessions has been largely confined to the 1.2650 to 1.2750 range. The MACD (Moving Average Convergence Divergence) moved to near neutral, as did the Relative Strength Index (RSI). This should in no way diminish the potential for movement, but the political threats in Ukraine have yet to have a major or lasting impact on the forex markets. The declining divergence of the MACD shows a decrease in upward momentum. The Average True Range (ATR) had stable volatility from Wednesday, but as with other indicators, it is not predictive in the current situation.

The 50-day moving average (MA) at 1.2707 has been above the 21-day MA for nearly a month. USD/CAD’s rebound from 1.2500 and stability around 1.2700 was well predicted. Monday’s upside turn in the 21-day MA and Wednesday’s steeper slope pointed to good support at 1.2670. Three of the moving averages, 21-day, 50-day and 100-day coincide with the support lines, giving the USD/CAD technical structure additional strength.

Resistance: 1.2775, 1.2800, 1.2840, 1.2855, 1.2915, 1.2940

Support; 1.2725, 12700 (50-day MA 1.2707), 1.2679, 1.2650 (21-day MA 1.2651), 1.2625 (100-day MA 1.2623)

FXStreet Forecast Survey

FXStreet’s forecast poll is slightly bullish in the near term but negative thereafter, regardless of the threat from Ukraine.