FX dynamics change as the US dollar extends its weakness, key CB decisions in focus

There was a slight rise in European stocks on Wednesday, as traders digested a large number of quarterly corporate earnings, particularly from the tech and banking sectors. These sectors play an influential role in the markets. After a three-day rally on Wall Street, stocks were mixed as major Asian indexes climbed and US futures fell because of slumps in Google parent Alphabet Inc. and Microsoft Corp.

China, Japan, and South Korea all recorded gains in equities, while contracts for the Nasdaq 100 slid. As a result of lower-than-expected revenue, Alphabet's share price dropped as much as 7% in after-market trading, while Microsoft's share price dropped as much as 8% following disappointing revenue forecasts.

Majors rebound in the wake of a weakening dollar

As traders reacted to more U.S. economic weakness, as well as to the prospect of intervention in Asia, the U.S. dollar edged lower during early European trading Wednesday, trading near a three-week low. Given such dollar weakness, the EUR/USD is likely to break above parity positively. Gold prices also found more room to grow, with buyers aiming for the 1675 mark. After hot inflation figures earlier on Wednesday raised pressure on the Reserve Bank of Australia to retain its aggressive monetary policy stance at its meeting next week, the AUD/USD rose 0.6% to 0.6432, its highest level since October 7.

In the most recent economic data released Tuesday, the U.S. government reported that home prices plunged in August as a result of rising mortgage rates reducing the demand for homes.

As a result of Monday's PMI release, which showed that U.S. business activity contracted for the fourth straight month, it is clear that the Federal Reserve's rate hikes are already harming the world's biggest economy.

Central banks’ meetings kick off today

Besides the earnings announcement, the Bank of Canada will kick off a week filled with several key central bank decisions with a meeting of the European Central Bank tomorrow and a meeting of the Bank of Japan on Friday.

As we saw in September, the Bank of Canada raised rates by 75 basis points after raising them by 100 basis points in July. Currently, rates are expected to rise by another 75 basis points to 4%. In the wake of the recent inflationary surge, there is already increasing evidence that wages are beginning to rise. It should be noted though that headline inflation appears to be slowing, with headline inflation falling to 7% in August, from 8.1% in June.

Even though markets are pricing an additional 75bps in today's price range, there is no guarantee that it is certain, as sharp declines in business sentiment are likely to factor into today's final decision. It is possible that the central bank at today's meeting might come up with a 50bps move and a hawkish outlook. This would enable it to avoid a 75bps move, which is what we've become used to in recent months,

Even though it appears that the increased focus on core prices in the US is fueling the dynamics in that country, the Bank of Canada may have a more cautious approach and lower the pace in the coming months as Canada has lower core prices than the US.

Moreover, it is widely expected that the Federal Reserve will authorize another 75-basis point rate increase next Wednesday as well. There is, however, a growing tendency to believe that any future hikes will be smaller in magnitude than what we've seen in the past.

The Bank of Japan, on the other hand, is expected to maintain its loose monetary policy settings on Friday, a stance which is believed to have significantly impacted the yen.

Concerning the former meeting, the Bank of Japan meets to set its monetary policy on Friday, and as long as we do not see a shift in its ultra-dovish outlook (a negative policy rate and continued quantitative easing), it seems difficult to expect a top in USD/JPY anytime soon. Likewise, the U.S. data calendar for this week should continue to maintain a hawkish outlook for the Federal Reserve.

There is a wide expectation that the European Central Bank will also raise rates by 75 basis points when it announces its policy on Thursday.