Currency markets are struggling to gain traction as political turmoil weighs on the euro, sustaining safe haven flows into the dollar, yen, and Swiss franc. Broader conditions look mixed, with North American equity futures little changed, bond yields ticking upward, crude prices nudging higher, and raw industrial commodity benchmarks slipping.
Ten-year French government bonds are still yielding roughly 80 basis points more than their German counterparts as uncertainty remains elevated ahead of the country’s two-round legislative election, which is set to conclude on July 7. Both Marine le Pen’s far-right National Rally and the left-wing Popular Front parties have made substantial advances in the race, with the most recent set of polls showing them garnering 35 percent and 26 percent of the vote, respectively, against the centre-right Renaissance’s 19 percent. If an opposition party wins an absolute majority, President Macron could be forced to “cohabitate” with a prime minister from the winning party, with the domestic policy agenda set outside his office.
The euro is holding near Friday’s lows and one-month implied volatility levels are grinding higher on the prospect of a worsening in France’s fiscal position. The National Rally’s platform is still somewhat unclear and le Pen has attempted to reassure investors, but the party is believed likely to favour cutting taxes, lowering the retirement age, and increasing public sector wages – steps that would worsen the budget deficit, while the Popular Front has vowed to unwind Macron’s economic reform efforts and increase overall spending in a repudiation of the European Union’s Growth and Stability Pact.
In 1962, President Charles de Gaulle famously said “how can anyone govern a country with two hundred and forty-six varieties of cheese?” but France’s issues are hardly unique: fiscal imbalances within the euro area have widened since the pandemic, with indebtedness in the core economies rebounding even as deleveraging in the peripheral countries moves into reverse. The euro crisis isn’t back, but a long period of artificial placidity in European fixed income markets appears to be coming to an end.
China’s yuan is drifting lower after monetary authorities left its key interest rate settings unchanged for a tenth consecutive month, defying expectations for a market-supportive easing in financial conditions. The People’s Bank of China kept its medium-term lending facility rate at 2.5 percent and pulled 55 billion renminbi in liquidity from the banking system in an apparent attempt to avoid triggering a renewed rally in onshore markets – a development which could endanger the country’s effort to shift the economy away from debt-fuelled property speculation and toward more sustainable types of activity.
US ten-year Treasury yields are down almost 25 basis points on a month-to-date basis after last week’s turbulence. Wednesday’s reassuringly-modest rise in consumer prices touched off one of the biggest rallies this year, with more hawkish-than-expected guidance from the Federal Reserve doing very little to halt the bond-buying activity later in the day. Despite an effort from Chair Powell to convince them otherwise, investors believe that the latest summary of economic projections – the “dot plot” – represents stale information, with incoming data likely to underscore the need to lower rates by the September meeting.
Traders still expect two rate cuts this year, and we think confidence in an imminent easing in policy could grow over the coming days. Tomorrow’s retail sales report will likely show consumer spending staged a modest recovery in May as strong personal earnings helped bolster activity, but underlying inflation-adjusted measures will likely remain weak. And by our count, Fed officials will make no fewer than eleven appearances this week, giving policymakers ample opportunity to focus on signs of slowing momentum while delivering a more dovish message than the one conveyed through the oft-misunderstood dot plot.
Amid a generalised paucity of data this week, a raft of central bank decisions will likely attract market focus. The Reserve Bank of Australia is expected to stay on hold, the Swiss National Bank could telegraph a September rate cut as it works to offset upward pressure on the franc, and the Bank of England might follow on Thursday with a more hawkish statement if Wednesday’s inflation print proves stubbornly resilient. Markets are currently assigning coin-toss probabilities to a rate cut in the UK by August, and the pound could experience reversals as traders jockey for position.
The consensus expects the Canadian loonie to weaken against the dollar through the back half of the year as the country’s central bank delivers more rate cuts – perhaps as many as three – relative to its southern counterpart before 2025 begins. Wednesday’s summary of deliberations could show Bank of Canada policymakers debating a more aggressive easing trajectory, and we remain wary of a volatility-led selloff in the run-up to the US election in the autumn – in fact, we think this scenario is deeply underpriced across markets.
We don’t want to sound Pollyannish – Canada is facing long-term underperformance as a decades-long debt binge ends – but we’re less convinced that the currency will see an inevitable decline this summer. With monetary easing expectations percolating into consumer activity levels and the flow of credit rebounding from last year’s crunch, upside risks exist, and a modest short-term recovery cannot be ruled out.
