So far, so good. A potentially-dangerous week in foreign exchange markets has started quietly, with most major currency pairs remaining tightly rangebound as traders brace for a raft of central bank decisions, data releases, and earnings reports over the coming days. The dollar is stable, Treasury yields are flatlining, and equity futures are setting up for a modestly stronger open. The Canadian dollar and other risk proxies are holding near Friday’s closing levels after the US Treasury Department’s latest borrowing estimate met market expectations, leaving bond yields flat during yesterday’s session, and reducing anxiety ahead of tomorrow’s quarterly refunding announcement.
The euro remains essentially unchanged after the economy grew faster—but also more inconsistently—than expected in the second quarter. On a bloc-wide basis, gross domestic product climbed 0.3 percent in the three months ended June, matching the first quarter, as the French economy posted a 0.3 percent quarterly growth rate against 0.2 percent in Italy, and 0.8 percent in Spain. Germany’s economy shrank -0.1 percent as weak export growth hammered business confidence and weighed on overall output levels. Data out tomorrow morning is expected to show harmonised inflation rising 2.5 percent in July relative to last year, keeping the European Central Bank on track toward a September rate cut.
The Japanese yen is softening ahead of tomorrow morning’s central bank decision, and could struggle to regain last week’s levels if policymakers fail to out-hawk markets. Traders are aligned in expecting the Bank of Japan to cut its monthly bond purchases from current levels, but there’s considerable uncertainty around the scale of the adjustment, and whether it will deliver a rate hike at the same time. Overnight index swaps are assigning coin-toss odds to a 10 basis-point move, but the range of possibilities is wide: officials could opt not to lift rates, to increase them in 5, 10, or 15-basis point increments, or to even to widen the target range for the uncollateralised overnight call rate, stopping short of providing a formal monetary tightening signal.
Japan’s decades-long flirtation with deflation has seemingly ended: data out last night showed slack in Japanese labour markets remaining practically non-existent in June, with a 2.5-percent unemployment rate helping bolster wage growth across the economy, and market-implied inflation expectations have risen considerably since the pandemic. But with stronger demographics, higher fiscal spending, and a more powerful innovation engine generating higher demand and faster growth in the United States, the cross-Pacific interest rate gap looks likely to persist for a long time yet. We suspect that the yen’s attractiveness to carry traders will stay intact for some time yet, with speculative flows remaining strong until a bigger economic shock hits the global financial system.
China’s yuan is pinned to the bottom of its allowable trading band as market participants gradually lose faith in the government’s stimulus plans. Authorities have spent the last few weeks rolling out measures designed to boost consumption—lowering benchmark lending rates, doubling incentives for electric vehicle purchases, and raising subsidies for home renovations, appliance upgrades, and equipment replacement—but with debt burdens at developed-economy levels and a huge share of wealth tied up in a property sector that continues to depreciate on a year-over-year basis, households and businesses remain reluctant to spend and invest. Government bond yields are holding near historic lows, reflecting extreme pessimism on the economy’s direction, and money supply growth—which in a modern economy helps act as a proxy for the pace of credit creation in the banking system—fell to 6.2 percent on a year-over-year basis in June, marking the lowest levels recorded in China’s post-Deng history.
Ahead today, the Conference Board’s measure of US consumer sentiment probably weakened slightly in July, but the heavily-partisan nature of US survey data has introduced too much noise and largely diminished its utility for traders. Microsoft will report second quarter earnings after the closing bell, with three of the other ‘magnificent seven’ companies following it later in the week.
June’s Job Openings and Labor Turnover Survey could calibrate expectations for the remainder of the week. The Bureau of Labor Statistics is seen reporting a modest decline in total job vacancies from 8.14 million to 8 million—dragging the ratio of openings to unemployed workers back below levels that prevailed just ahead of the pandemic’s impact three years ago—and the quits rate should hold near 2.2 percent, remaining indicative of strong confidence in labour market conditions. But with continuing claims levels rising in recent months and Worker Adjustment and Retraining Notification numbers pushing higher across a range of states, it is the layoffs number that might deliver a nasty surprise, setting the stage for a more dovish turn from Federal Reserve officials in tomorrow’s meeting.
The central bank is widely expected to leave its major rate settings unchanged, but the tone delivered in the statement and post-decision press conference could help shape expectations ahead of the Jackson Hole Economic Symposium and September policy meeting. In the statement, officials are likely to acknowledge having made further progress in bringing down inflation, and will almost certainly describe the outlook as having become more “balanced,” with labour market concerns coming back to the forefront after years spent playing second fiddle to price pressures in driving policy settings. We don’t have strong conviction in what Powell will say during the press conference—and suspect markets will interpret his comments through a dovish filter anyway—but we think that he will work to preserve optionality while building up to a decisive pivot in September.