The two best performing currencies today were the Australian dollar and euro which is a bit ironic because the Reserve Bank of Australia and the European Central Bank are two of the least hawkish central banks. Yet central bank expectations are the reasons why AUD and EUR soared on Monday.  Traders and investors are worried that the RBA and ECB could turn less dovish and start to align themselves with other central banks that plan to raise interest rates in early 2022.  Having fallen to 1.5 year low last week, AUD/USD rallied on the back of short covering.  Euro soared on the back of stronger German inflation data. 

Tonight should be a busy one for the Australian dollar.  Retail sales will be released before the Reserve Bank of Australia meeting. Consumer spending should be healthy given the rollback of restrictions in the fourth quarter.  At their last meeting, the RBA said they don’t see rates rising until 2024 but with central banks around the world tightening, they may have to adjust their outlook.  This could come in the form of upgraded assessment of the labor market and inflation.  They could also talk about ending bond buying which would be a step taken before rates are increased.  If any of these things happen, AUD could extend its gains quickly.

No changes are expected from the European Central Bank but traders are betting on a year-end rate hike with futures pricing in quarter point hike by the end of the year.  If the Fed hikes by 100bp this year, a 25bp move by the ECB would not be out of the question but we doubt that President Lagarde will drop any hints of that possibility at this week’s meeting.  German retail sales and labor market numbers are due for release on Tuesday. According to the PMIs, jobs were added at a faster pace in the month of January. 

The Federal Reserve may be one of the most hawkish central banks but the U.S. dollar traded lower against all of the major currencies. The Chicago PMI index was stronger than expected signaling upside surprise for the ISM manufacturing index scheduled for release on Tuesday.  With the market fully discounting next month’s rate hike and policymakers clarifying that it will most likely be a quarter point and not half point move, there was little upside to the dollar.  Non-farm payrolls are due for release on Friday and while this is typically a very market moving release, it is expected to less so this month.  NFPs help to shape expectations for FOMC but the market is pretty confident in what the Fed has in store.  

The continued rise in oil prices helped drive the Canadian dollar higher. The New Zealand dollar also traded firmly ahead of the Reserve Bank’s monetary policy announcement.  The country’s trade deficit shrank significantly at the end of the year.  Sterling extended its gains for the second day in the row with the Bank of England being the only central bank that could tighten this week.