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Market Briefing: Dollar Rally Pauses as Global Policy Landscape Shifts

Equity markets are poised for a strong open and the greenback is retreating ahead of data that could reinforce the “peak inflation” narrative and influence longer-term monetary policy expectations. The trade-weighted dollar is slipping from multi-decade highs and a broad-based improvement in risk appetite is visible across most major asset classes, suggesting that traders and investors are cutting short positions in preparation for tomorrow’s August consumer inflation report.

The euro is powering higher, extending its biggest rally in at least six months as interest rate differentials narrow. The spread between US and German yields narrowed to a one-month low over the weekend after Bundesbank President Joachim Nagel – long one of the most hawkish members of the European Central Bank’s rate-setting council – said “further clear steps” might be required to bring inflation down. Ukraine’s battlefield successes may also be playing a role, encouraging European countries to continue delivering aid and weapons, while bolstering domestic support for fiscal measures that offset sanctions against Russia.

But the common currency’s gains could prove fleeting. Positioning adjustments could fade, and longer-term issues haven’t been resolved: energy prices remain extremely elevated, a coordinated European Union policy response is likely to follow historical examples by getting bogged down in the details, and the Ukrainian advance could yet become dangerously overstretched, triggering a unwind in optimistic narratives.

Haruhiko Kuroda’s jawboning efforts are helping put a floor under the yen. The Bank of Japan governor called moves in the exchange rate “undesirable” on Thursday, lending implicit support to interventionist threats from the Ministry of Finance, while helping shift the risk and reward calculus for traders with heavy short positions on the currency.

The Canadian dollar is climbing, shrugging off last week’s disappointing jobs report to move higher with crude prices. Friday’s confirmation of a third consecutive monthly decline in Canadian employment hasn’t shaken monetary policy expectations, with most investors convinced the Bank of Canada will forge ahead with rate hikes against a still-overheated economic backdrop.

Oil prices are inching higher as the dollar declines and bets on an Iran nuclear deal fade – but demand worries are capping gains. Over the weekend, France, Germany, and the United Kingdom noted “serious doubts” about Iran’s willingness to curtail its nuclear programme in exchange for a lifting of sanctions. Continued coronavirus lockdowns in China, tight budgets in Europe, and slowing American consumption are all contriving to put downward pressure on the demand outlook for the months ahead. West Texas Intermediate is changing hands for $87 a barrel, and Brent – the global benchmark – is flirting with the $94 mark, both up roughly 1 percent on the session.

There are no major data releases scheduled in North America today.

Markets think tomorrow’s data will show consumer inflation pressures ebbing for a second consecutive month in August, with falling gasoline, car, and travel costs helping offset still-rising food, household product, and services prices. Headline prices are expected to drop 0.1 percent after flatlining in July, and the core measure is seen holding at 0.3 percent month-over-month, down from June’s 0.7 percent pace.

Few imagine this will dissuade policymakers agitating for a 75 basis point hike at next week’s Fed meeting. Most major US indicators look representative of an economy that is growing at a solid pace, creating an unexpected number of new jobs, and generating strong inflation pressures across a range of product categories. Central bankers have warned they intend to continue “front-loading” rate increases, and market odds on a jumbo-sized move are floating well above the 90 percent mark.

But signs of a sustained deceleration in price growth could lower rate expectations for 2023, deepening last week’s reversal in the dollar and lifting currencies in the rest of the world.

Expect volatility.

Karl Schamotta, Chief Market Strategist

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