Global markets are bowing before the almighty dollar once more as investors brace for Friday’s central bank conference in Jackson Hole, Wyoming. Every major US equity index ended yesterday in the red, commodities are down again, and risk-sensitive currencies are in retreat.
Markets think Mr. Powell will assert the Federal Reserve’s intent to lift rates into restrictive territory – and keep them at those levels – in Friday’s speech. Terminal Fed Funds expectations have shot up from 3.25 percent in late July to 3.75 percent now, and implied rate cuts have fallen by more than a third as investors have become more convinced of the central bank’s “soft landing” thesis. We doubt this belief will survive an encounter with reality in the early autumn, but there could be momentum in it yet.
The euro is trading below parity after yesterday’s plunge. The move was sparked after Russia’s Gazprom said on Friday it would shut the Nord Stream pipeline three days of maintenance later this month – a move that reawakened fears of a geostrategic effort to choke off European energy supplies. Gas and electricity prices are setting records across the bloc, threatening to cap the European Central Bank’s tightening efforts and drive the economy into a deeper slowdown.
Euro-area economic activity declined for a second month, making a third-quarter recession more likely. The S&P Global Composite Purchasing Managers Index for the common currency zone fell to 49.2 in early August from 49.9 in July — a reading below 50.0 indicates a contraction — as both the manufacturing and services sectors reported drops in new orders.
Activity in Australia and Japan also slowed, with composite purchasing manager indices falling to 49.8 and 49.6 from 51.1 and 50.2 respectively in the prior month. Markets still expect a 50 basis point hike from the Reserve Bank of Australia in September, and the embattled Kishida government is likely to approve additional stimulus in Japan. Both the Aussie and the yen have struggled to make headway against the dollar, remaining largely rangebound as tectonic movements happen elsewhere in the currency markets.
Oil prices are recovering from yesterday’s whiplash session. The major benchmarks dropped more than 5 percent on the prospect of a nuclear deal with Iran before reversing when Saudi Arabia’s Energy Minister Prince Abdulaziz bin Salman appeared to threaten production cuts. Barrels of West Texas Intermediate and Brent are going for roughly 6 percent more than a week ago as pressures on the global energy grid increase.
The Canadian dollar firmed slightly overnight, but is still trading on the colder side of a key psychological level as global risk aversion overwhelms gains in the oil complex. With traders expecting the Bank of Canada to hike more aggressively and hold rates for longer, two year Canadian yields are richer than their US equivalents, but the interest differential flips farther out on the curve, with US instruments offering slightly higher rates.
China’s renminbi tumbled to a two-year low against the greenback, touching 6.88 in offshore markets last night. Worsening domestic fundamentals and widening yield differentials are weighing on the exchange rate, but the move has been largely confined to the dollar-yuan pair. On a trade-weighted basis, the currency is up year-to-date.
US new home sales likely fell in July, dropping to 575,000 from 590,000 in the prior month as higher interest rates and weaker income growth hit the housing market.
Tread carefully out there. We would caution that late August trade patterns often reflect post-summer shifts in market positioning rather than underlying fundamentals. This week’s moves could fade quickly – particularly if something breaks loose on the energy front or Friday’s Jackson Hole meeting turns out to be a damp squib.
Note: Sorry for distributing this morning’s missive so late – encountered some technical problems in the writing process.
Additional disclosure: The “technical problems” involved having coffee on the deck with a good pupper, and losing track of time.
Karl Schamotta, Chief Market Strategist