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Market Briefing: Year-end rebalancing flows weigh on dollar into quiet data week

The dollar continues to lose altitude as market participants gradually rebalance portfolios ahead of a new calendar year. With US economic outperformance fading, the Federal Reserve expected to slow and then pause its tightening cycle, energy prices falling, and geopolitical shocks fading, many investors have become less willing to crowd into long-greenback positions, and demand for alternatives is growing.

Oil prices are steady even after the Group of Seven industrialized democracies agreed to cap shipments of Russian crude at $60 a barrel. Under the plan, Western companies will be barred from insuring, financing, or shipping Russian oil unless it is sold below the threshold. Few expect this to dramatically alter global supply and demand balances, and the impact on Russian export revenues is likely to prove minimal.

China’s yuan is trading for less than 7 per dollar for the first time since September as investors turn more optimistic on the prospects for a wider reopening of the economy. The offshore renminbi is holding near the 6.95 mark after officials in a number of the country’s largest cities said they would ease “zero-covid” restrictions and increase efforts to vaccinate the elderly population.

A quiet week for economic data beckons. In the US, the Institute for Supply Management’s services index will land later this morning, the latest trade numbers tomorrow, and producer prices and consumer sentiment on Friday. Fed officials are in purdah ahead of next week’s meeting.

The Reserve Bank of Australia is expected to hike its cash rate by a quarter percentage point at this evening’s meeting. Headline inflation rates are showing signs of rolling over, wage increases have been relatively subdued, and the housing market—with its heavy reliance on variable-rate mortgages—has slowed materially in recent months as conditions have tightened. Officials may use the statement to telegraph a slower pace of rate increases in February and beyond.

Markets think the Bank of Canada will deliver a quarter-point rate hike on Wednesday, although some economists consider a half-point move more likely. Another aggressive jump is possible, but we think a smaller increment is slightly more likely – given that the bank has raised rates six times since March. Individual and corporate borrowers have been subjected to a historic jump in carrying costs, and signs of a slowdown in the economy are multiplying. Household consumption fell 0.3 percent and residential investment plunged 15.4 percent in the third quarter, and most forecasters expect the country to flirt with recession in the coming year. Canada also possesses the most inverted 10-2 year yield curve among major economies outside Russia, suggesting that markets are bracing for a more prolonged downturn. A more cautious approach would be well-justified.

Karl Schamotta, Chief Market Strategist

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Higher for (even) longer