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Central Bank Easing Hints Boost Risk Appetite

The dollar is reversing an early-week decline and Treasury yields are creeping higher as market participants return from yesterday’s US holiday. North American equity futures are adding to their gains, and a broader improvement in sentiment is helping feed through into appreciation in high-beta currencies – like the Canadian dollar – amid still-thin trading conditions.

A surprise easing decision from the Swiss National Bank is helping bolster liquidity expectations. Officials in the financial safe haven elected to lower inflation projections and deliver a 25 basis point rate cut as they work to reduce restrictiveness and counter recent strength in the franc, with President Thomas Jordan describing the new policy settings as “balanced” in a Bloomberg Television interview after the decision. The currency has appreciated in recent months, but low interest rates and an intervention-prone central bank are helping it maintain a small, liquidity-enhancing role in funding the global “carry trade,” in which traders borrow in low-yielding jurisdictions and invest in higher-yielding alternatives.

The pound is trading with a weaker bias after the Bank of England hinted at an imminent shift onto a more accommodative footing – increasing the likelihood of an August move – even as it kept policy settings unchanged in its latest decision. Just two members of the Bank’s policy committee – Swati Dhingra and Deputy Governor Dave Ramsden – again backed a cut, but the meeting record described the decision for the other seven as “finely balanced,” implying that more data could push the majority toward easing rates in August. In comments issued alongside an unchanged statement, Governor Bailey said “We need to be sure that inflation will stay low and that’s why we’ve decided to hold rates at 5.25 percent for now,” triggering a near-doubling in odds on a rate cut at the August decision – from below 30 percent to almost 60 percent.

Data out yesterday showed headline inflation hitting the Bank’s target for the first time since the spring of 2021, but price growth in the services sector remained uncomfortably high at 5.7 percent year over year, 0.4 percent above the forecast embedded in the May Monetary Policy Report. With another consumer price index report due before the Bank meets in August, we suspect that relief is coming: the vacancy-to-unemployment ratio in services – which typically foreshadows changes in wage growth – is pointing to softness ahead, and a range of other indicators are suggesting that salary demands are easing. It seems many policymakers are of a similar bent, with the meeting minutes saying “The upside news in services price inflation relative to the May report did not alter significantly the disinflationary trajectory that the economy was on”.

The euro is coming under modest selling pressure after the European Commission backed taking disciplinary action against France and Italy over their borrowing levels, adding to debt sustainability concerns at the core of the common currency area. The Commission, which is nominally responsible for monitoring compliance with the European Union’s budget rules, recommended launching an “Excessive Deficit Procedure” – which is triggered when a country’s fiscal imbalance exceeds 3 percent of gross domestic product or its government debt-to-gross domestic product ratio exceeds 60 percent and is not diminishing at a ‘satisfactory pace’ – against France, Italy, Belgium, Slovakia and Malta in the euro area, along with Poland and Hungary outside it.

We doubt the Commission’s efforts at shaming governments will do much to shift the political calculus in the upcoming French legislative election. The Excessive Deficit process can theoretically lead to fees amounting to 0.05 percent of gross domestic product, and ineligibility for protection under some of the European Central Bank’s bond-buying programmes, but parties on both ends of the French political spectrum – the right-wing National Rally and the left-wing New Popular Front – have outlined plans that would likely take debt even higher, suggesting that they don’t take the these penalties terribly seriously. Fiscal discipline is beginning to make a comeback across the wider euro bloc, but big differences between government deficit levels – as depicted below – mean that stresses will continue to build within the common currency area.

China’s yuan is trading near an eight-month low as traders bet the central bank will continue slow-walking the currency lower in an effort to provide more domestic monetary accommodation and boost external competitiveness. The People’s Bank of China last night set its fix – the mid-point level that determines the allowable trading range – at 7.1192 per dollar, the lowest since November, and the so-called “national team” of state-directed banks and securities firms neglected to step in as the currency edged toward the top of its band. The yuan hasn’t yet hit last year’s lows, but its decline could have wider consequences as ‘renminbi bloc’ currencies like the South Korean won, Indonesian rupiah, Malaysian ringgit, Philippine peso, Taiwanese dollar, Singaporean dollar, Thai baht – and arguably the Indian rupee – edge lower. Further appreciation in the trade-weighted greenback could exacerbate negative rhetoric surrounding the US trade deficit, and put exchange rates back in the crosshairs for politicians campaigning in this year’s presidential election.

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