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Another day, another (more expensive) dollar

The greenback keeps moving from strength to strength, with the “US outperformance” trade gaining renewed momentum as risk appetite falls and signs of weakness grow more evident in other parts of the global economy. Equity futures are softening this morning as reports of a Chinese government ban on Apple devices drive the technology company’s shares lower. Yields are slightly lower at both the two- and ten-year horizons, and most major currencies are down against the dollar. 

Yesterday, when the Institute for Supply Management said its index of service-sector activity had risen to a six-month high, with improvements seen in virtually every category from new orders to employment, investors reacted badly, sending long-term yields shooting higher and equities tumbling.

Admittedly, sustained resilience – combined with the inflationary impact of higher oil prices – could render early-2024 rate cuts more unlikely and keep US yields elevated for longer. But the direction of travel in US consumption patterns is very likely to move down in coming months as labour markets slow, excess savings are depleted, student loan payments resume, and cultural phenomena like “Barbenheimer” and the Taylor Swift tour fade away. Buying the dollar on extrapolations from recent data could prove hazardous if long-term rate expectations ultimately revert lower. 

The euro is on the defensive ahead of next week’s European Central Bank meeting after second-quarter growth was revised lower and German factory output kept contracting. Eurostat said gross domestic product in the common currency zone rose 0.1 percent in the three months ended in June, down from the 0.3 percent previously reported, and numbers released by Germany’s statistics agency showed industrial production tumbling another -0.8 percent in July, bringing it down roughly -4 percent relative to the levels that prevailed prior to Russia’s invasion of Ukraine. We think the odds favour another rate increase as policymakers work to stamp out still-persistent underlying inflation – even as the economy shows clear evidence of slowing – but markets are convinced otherwise, and the euro is struggling to gain traction against the dollar. 

China’s yuan is trading near its lowest levels since 2007, largely ignoring better-than-expected trade data. Data released last night showed the dollar value of exports down 8.8 percent in August from a year earlier, while imports shrank 7.3 percent, generating an above-forecast $68 billion surplus – but markets remain tightly focused on financial instability risks and on signs of a slowdown in the broader economy. Authorities seem to be slow-walking the currency’s decline, but no obvious “line in the sand” has yet been drawn to signal where the selling should stop. 

And the other big factor in trade-weighted measures of the dollar – the Japanese yen – is moving decisively below the levels that triggered intervention last year. The currency seems to be pushing toward the 150 threshold, with hugely negative rate differentials sustaining carry trade activity and outward capital flows even as official jawboning efforts become more strident. We suspect authorities could follow previous precedent in deploying currency reserves to smooth volatility after regular trading hours, perhaps as early as this weekend, but arguments for a decisive shift in the Bank of Japan’s policy settings remain weak, at best – and the yen looks likely to stay depressed for a prolonged period of time. 

The Canadian dollar is treading water, almost unchanged relative to the levels that prevailed before yesterday’s Bank of Canada decision served to anchor rate expectations modestly upward. Governor Tiff Macklem is scheduled to speak later today, and markets will be paying close attention to his views on the interaction between growth and underlying inflation trends. We would argue that his words are more likely to spark volatility than the announcement itself did – it’ll be significantly more difficult to square the circle between slowing economic growth and a “higher for longer” policy outlook in a more lengthy speech and press conference. 

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