Foreign exchange rates are looking relatively stable this morning, with modest price action largely dictated by events in stock markets. Equity futures are down – putting some pressure on risk-sensitive currency pairs and raising the dollar’s safe-haven value – after Tesla, LVMH and Deutsche Bank reported disappointing earnings. Treasury yields are inching lower, but remain elevated on the back end as investors brace for continued fiscal expansion under either of the current front-runners for US president.
The euro is trading near a two-week low after private sector activity decelerated more than expected in early July, suggesting that an early-year economic recovery is running out of steam. The S&P Global composite purchasing manager index fell to 50.1, down from 50.9 in the prior month, and just above the 50 threshold that separates expansion from contraction. Sentiment in the German economy hit a wall, shrinking on a month-over-month basis as the manufacturing sector ran into renewed headwinds, but input price growth accelerated on a bloc-wide basis. The European Central Bank is seen easing slightly more aggressively in the coming months, with four cuts fully priced into overnight index swap markets over the next year, up from the three-and-a-half expected last week.
The Japanese yen is holding at a two-month high as market participants hedge against the possibility of a rate hike at next week’s Bank of Japan’s meeting. A move above the current 0-to-0.1-percent range is fully priced in over the next three meetings, but the timing remains uncertain as a depressed yen, sticky inflation, and consistent wage gains translate into a clearer monetary tightening imperative in the near term. Most observers expect an announcement on quantitative tightening at the least, and speculative demand for short positions has evaporated as traders dodge official intervention efforts and narrowing rate differentials.
Investors overwhelmingly expect the Bank of Canada to deliver a second consecutive rate cut in a few hours. We still think waiting till September makes the most sense, but with consumer spending falling, unemployment rising, and survey data pointing to more weakness ahead, the balance of risks has unquestionably tilted in favour of an earlier cut.
Market-implied odds on a move are hovering around the 85-percent mark, suggesting that the decision itself could prove dramatically underwhelming – but a surprisingly cautious tone could emerge in the accompanying Monetary Policy Report and post-decision press conference. Price growth showed signs of re-acceleration last month, with disinflation slowing across a range of categories while core measures sped up on a three-month annualised basis. High levels of immigration may be distorting job market signals. External demand remains strong. And the country’s speculation-addicted populace hardly needs any encouragement to push housing values to even-less affordable levels. We believe Tiff Macklem and Carolyn Rogers will try to downplay the Bank’s perceived easing bias, emphasising upside risks while warning markets not to expect cuts at consecutive meetings going forward.
There are no major data releases on the agenda for today’s session. S&P Global’s US purchasing manager index is expected to remain firmly in expansionary territory when released later this morning, but tomorrow’s second-quarter US gross domestic product report and Friday’s personal income and expenditures report look likely to dominate trading in interest rate futures and the dollar itself. Next week, the Federal Reserve is seen providing early hints of a pivot toward cutting rates in September, but
The US political outlook remains deeply uncertain. Prediction markets continue to show the Republicans in the lead ahead of the November election, but the gap between the two major parties has narrowed substantially, essentially unwinding the effects of President Biden’s performance during the first presidential debate in late June. A Reuters-Ipsos poll performed on Monday and Tuesday showed Kamala Harris ahead of Donald Trump by two percentage points, up sharply from last week’s levels, while an NPR-PBS News-Marist poll conducted on Monday found Trump leading Harris by one point. Both were within the polls’ margin of error.
The market implications are even more difficult to parse. As outlined previously, the domestic and global economies have changed dramatically since Donald Trump’s first term, making it unwise to apply the same trading framework to his second. No one knows whether his campaign pledges to deport illegal immigrants, raise tariffs and cut taxes will reach fruition, and it’s impossible to quantify the potential consequences for inflation, interest rates and government finances. His policy proposals have both positive and negative implications for the dollar, with the balance unlikely to be resolved until long after taking office.
Although Harris is now overwhelmingly likely to become the Democratic Party’s nominee, she remains something of an unknown quantity from an economic policy perspective. As a presidential candidate, she veered to the left, but there hasn’t been a lot of visible daylight between her and Joe Biden in the intervening years: as Vice President, she supported his infrastructure investment, clean energy, and student loan reduction initiatives, and she seems to favour his tax agenda, which would increase the burden on corporations and households making more than $400,000 a year while reducing it for lower-income cohorts. On trade, Kamala has opposed Trump’s tariff plans, claiming that she is “not a protectionist Democrat,” but also says she would not have voted for NAFTA or the Trans-Pacific Partnership due to climate provisions.
What we do know is that both candidates favour a bigger role for government in the economy, meaning that political imperatives will increasingly dictate the conditions under which businesses operate. This is not new: regulatory burdens and trade-hostile measures have been increasing across administrations and governing parties for decades. But it does have implications for currency markets – as the global geopolitical situation becomes more fraught and the US economy (arguably) becomes more like China’s, financial models that use quantitative factors to predict exchange rate moves are becoming less useful. Instead, the skills that helped George Soros become rich in the eighties and early nineties – the ability to foresee how political changes might intersect with economic fundamentals in redirecting global capital flows – are coming back into vogue. Against this backdrop, we think volatility expectations remain too low.
