The dollar is back on the defensive after new data showed the US labour market cooling rapidly, increasing odds on a dramatic opening salvo in the Federal Reserve’s easing cycle later this month. Treasury yields are stabilising after yesterday’s tumble and equity futures are advancing ahead of this morning’s weekly jobless claims number, but directional position-taking remains restrained, with tomorrow’s non-farm payrolls report poised to play a pivotal role in determining market outcomes across virtually every major asset class.

The number of job openings fell in July to the lowest level since the start of 2021, according to yesterday’s Job Openings and Labor Turnover report, dropping to 7.67 million from a downwardly revised 7.91 million in June. The gap between demand for workers (the total number employed plus the number of job openings), and supply (the total number of people in the workforce), shrank to 510,000 positions, down from 1.1 million in the prior month, and far below the 6.2 million reached in early 2022.

Traders are back to betting on a jumbo-sized rate cut at the Federal Reserve’s September meeting. Futures markets are assigning 43 percent odds to a half-percentage-point move on September 18, with a rate cut expected at every meeting between now and the end of next year, bringing the Fed Funds rate down to less than 3 percent by early 2026.

The yield curve has “dis-inverted”, raising slowdown fears. An inversion in the typically-positive difference between two- and ten-year Treasury yields has historically preceded a US recession by one to two years, but a return to positive territory has almost always signalled its imminent onset, with a lag of two to six months. This time may be different* though – the yield curve has been inverted for more than two years, marking its longest period in negative territory since 1978, and many other traditional recession indicators have thus far failed to translate into an actual downturn.

All of this means that the stakes are unusually high going into tomorrow’s non-farm payrolls report. Traders are preparing for major moves in fixed income and foreign exchange markets, and it is reasonable to expect a violent widening in trading ranges just after the 8:30 release. But the degree of pessimism now built in also carries risks of its own – if job creation and unemployment rates fail to bear the scarring typical of a cooling labour market, short-term yields could spike higher, derailing the current dollar-bearish consensus in foreign exchange markets.

The Canadian dollar is clinging to gains achieved after the Bank of Canada paired yesterday’s rate cut with a surprisingly unsurprising set of communications. The statement itself acknowledged growing downside risks, but took a somewhat benign view on growth and employment dynamics, suggesting that officials aren’t unduly alarmed by the economic data they’re seeing. Governor Tiff Macklem again said “it is reasonable to expect further cuts in our policy rate,” but downplayed the likelihood of an oversized move, indicating that the slow and steady easing pace already priced into overnight index swaps remains a good base case for market participants.

We’re tactically bullish on the Canadian dollar, but strategically bearish**. Given that the Fed’s policy rate is significantly deeper in restrictive territory, and that Chair Powell’s Jackson Hole appearance clearly outlined a jobs-driven reaction function, the currency weakness baton has been passed to the greenback for now – but long-standing productivity and indebtedness problems mean that the Canadian economy remains far more vulnerable in the long run. The loonie might grind a few cents higher in coming months, but an extreme selloff in US markets or a rapid slowing in the global economy could trigger a sharp unwind at any time, knocking the exchange rate back to early-August levels in short order.

Japan’s yen is incrementally stronger after inflation-adjusted worker wages climbed by more than expected in July, helping ratify a consistently-hawkish tone from central bank Governor Ueda. Real cash earnings rose 0.4 percent in July from the year prior, decelerating from the 1.1 percent jump recorded in June, but well above market expectations for a -0.6-percent decline. Most observers expect the Bank of Japan to deliver another rate hike in coming months, but the global market context remains important – Ueda and his counterparts have signalled a desire to avoid triggering another round of turbulence akin to the early August selloff, helping shift the balance of risks toward a later move.

Mexico’s peso is taking a serious drubbing, suffering losses that put it neck-and-neck with the Argentinian peso as the world’s worst-performing widely-traded currency this year. This comes after the lower house of Congress approved the text of President Andrés Manuel López Obrador’s judicial reform bill, making it likely that core aspects of the legislation – which is intended to open the country’s judiciary to popular elections – will make it through approval from the Senate before the end of September. The far-reaching proposal is widely expected to remove critical checks and balances on the government, and further reduce foreign appetite for pouring money into the opportunity-rich, but corruption-infested and infrastructure-poor country. Despite widespread talk of “friend-shoring” among the US intelligentsia and promises of massive factory construction from the likes of Elon Musk, our estimates indicate that new foreign investment in Mexico has fallen sharply over the last year, limiting the extent to which the country can gain from the realignment of geopolitical alliances that is remaking global supply chains.

*Sir John Templeton said “The four most expensive words in the English language are ‘this time it’s different’” – although “I do” might be close rivals.

**This is sell-side nonsense for: I think the Canadian dollar could kick slightly higher if the US non-farm payrolls report doesn’t kill risk appetite, but will likely drift lower again by year end once the Fed’s easing trajectory is fully priced in and bears turn their focus back to weaknesses in the Canadian economy. Remember of course, that foreign exchange strategists are almost always wrong, and focus on building a trading strategy that protects your bottom line in the event of moves in either direction.