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13 Jul 2023

USD doldrums

• Weaker USD. Lower than expected US CPI was compounded by soft PPI inflation. US bond yields have fallen back further. The USD has weakened.• Risk sentiment. The shift in interest rate expectations has boosted risk appetite. Equities & commodities higher. The AUD has jumped up.• Too far too fast? Markets have moved a long way very quickly. Inflation is heading in the right direction, but central banks may not declare victory just yet. The adjustment in markets following the lower-than-expected US CPI data (released two nights ago) has continued with softer producer price inflation reinforcing the ‘disinflation’ theme. Equities...

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The “superpeso” has gone from strength to strength.

The Mexican peso enjoyed this century’s second-strongest bull run in the first half of the year, with wide rate differentials, stable public finances, “nearshoring” hopes, and surging inward remittance flows, combining to send the exchange rate soaring. The Banxico’s commitment to maintaining benchmark interest rates at least 600 basis points above their US equivalents has done much of the heavy lifting, with returns on dollar-funded trades exceeding 19 percent this year. Despite a reputation as a leftist economic nationalist, President Andrés Manuel López Obrador has proven less interventionist and more fiscally conservative than investors once feared. The country has pushed...

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Risk / reward balances are shifting in the yen’s favour.

It was one-way traffic for the Japanese yen in the back end of the second quarter. The currency depreciated sharply against a range of other majors, with the US dollar touching a 7-month high, the Australian dollar hovering around the top end of its 9-month range, and the euro hitting its highest level since the third quarter of 2008. Markets were clearly underwhelmed by the lack of action at the late-April Bank of Japan meeting, the first for newly-appointed Governor Ueda. Over the same period interest rate expectations for other major central banks like the Reserve Bank of Australia, Bank...

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Divergent policy expectations are powering euro gains.

After narrowly avoiding recession earlier in the year, the euro area economy continues to generate above-target inflation, forcing policymakers to maintain a consistently-hawkish stance. The European Central Bank’s series of interest rate hikes is expected to remain uninterrupted for several months to come, with investors currently pricing in two more moves – one later this month, and another in September. With rate differentials narrowing in its favour and the dollar staging a broad-based retreat, the euro has turned in a respectable performance since bottoming out in late 2022, and gains have accelerated since softer-than-anticipated consumer price numbers drove US yields...

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“Nearshoring” hopes could be overplayed.

With geopolitical tensions between the US and China forcing businesses to diversify supply chains, the country’s stability, low labour costs, and geographic proximity have raised hopes that a “Made in Mexico” moment is at hand. But if US demand for tangible goods slows, and vehicle prices flatline, export growth won’t continue at the pace that has been set over the last year. Under López Obrador, energy policy has become less flexible and even less climate-friendly, limiting the extent to which companies with net-zero commitments can relocate production facilities. Critical regulatory bodies remain captive to political whims. And the country devotes...

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