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Market Briefing: Dollar Rally Pauses as Global Policy Landscape Shifts

The dollar is pausing for breath after stampeding through global financial markets for more than a week. The euro, pound, and yen are exhibiting signs of stability ahead of a central bank decision in Europe, fiscal intervention in the UK, and a senior-level policy meeting in Japan.

The European Central Bank is expected to raise all three of its benchmark rates by 75 basis points, tightening policy aggressively as it moves to keep inflation expectations under control.

The euro could remain weak as investors focus on painful price pressures and looming recessionary threats, with the central bank’s updated projections for inflation and economic growth poised to garner more attention than the decision itself.

The pound is recovering after new Prime Minister Liz Truss announced plans to hold average household energy bills at no more than 2,500 pounds from October 1, reducing the likelihood of an inflationary overheat that forces the Bank of England into raising rates more quickly. Prior to the announcement, the exchange rate broke through its 2020 nadir, briefly reaching levels last seen in 1985.

Market-implied odds on a 75 basis point hike at the Federal Reserve’s late September meeting jumped to near-certain levels after the Wall Street Journal’s incredibly well-connected Nick Timiraos published an article saying the central bank was “on a path” toward a such a move. Timiraos played a critical role in adjusting market expectations ahead of June’s jumbo-sized hike.

Vice Chair Lael Brainard warned rates would move higher and remain there for some time, telling bankers “We are in this for as long as it takes to get inflation down,” before acknowledging the “two-sided” risks that will emerge once policy is in restrictive territory.

Chair Jerome Powell is likely to repeat this message in this morning’s comments. Mr. Powell is scheduled to take part in a conversation about monetary policy at a Cato Institute event in a little more than an hour, with markets watching closely for any shifts in language after yet another surprisingly-strong employment report.

US jobless claims are expected to rise to 235,000 in the week ended September 3, up modestly from 232,000 in the prior week. To date, no conclusive evidence of a loosening in labour market conditions has become available, but September is notorious for noisy data, and it could be mid-October before a clear narrative emerges.

Canada’s loonie eked out modest gains overnight as oil prices climbed off post-Ukraine invasion lows, but remains on the defensive as investors bet on a more gradual series of rate hikes in the months ahead. Interest rate differentials are holding steady relative to levels that prevailed ahead of yesterday’s policy decision, with overnight rates expected to peak around 4 percent by the end of the year, before beginning to slide in 2023. Deputy Governor Carolyn Rogers could help calibrate expectations when she delivers an economic update in Calgary later this morning.

Karl Schamotta, Chief Market Strategist

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