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Market Briefing: Dollar Weakens as Risk Appetite Grows

Sometimes, sentiment in markets can defy easy explanation, requiring lots of nuance and many caveats to describe. At other times, the mood be summed up on the front of a Hallmark card. Today, it’s a 50th birthday card that says “it’s all downhill from here”.

Investors remain convinced a softening economy and weaker price pressures will convince the Federal Reserve to slow rate increases – leading to a loosening in financial conditions that supports asset prices. Long-term Treasury yields are down, and the trade-weighted dollar is headed for its steepest weekly loss in at least two months. Commodity prices are climbing, providing lift to exporter currencies. And equity indices are poised for a slightly stronger open.

But core inflation remains well above the Federal Reserve’s comfort zone, and looks likely to remain there for many months to come. Headline prices may have peaked, with food and energy benchmarks coming under pressure, yet measures of underlying inflation have hardly fallen.

And Federal Reserve officials are still making hawkish noises. San Francisco Fed President Mary Daly yesterday told Bloomberg she thought a 50 basis point hike was most likely at the central bank’s September meeting, but that she would consider a larger move if inflation pressures moved in an unfavourable direction. Richmond President Thomas Barkin is likely to say something similar when he speaks with CNBC at 10:00 am this morning.

We worry about what might unfold when markets read the inside of the card.

Mexico’s central bank raised rates as expected yesterday. In a widely-anticipated move, policymakers lifted inflation forecasts and voted unanimously to lift the overnight rate by 75 basis points, while signalling further increases to come. Swaps pricing suggests Mexican rates will top out between 9.25 and 9.50 percent by year end, sufficient to attract carry trade activity from currency traders. The peso remains relatively stable.

The British economy shrank by less than forecast in June. Data released by the Office for National Statistics this morning showed gross domestic product fell -0.6 percent in the month, less painful than the -1.3 drop that had been pencilled in by economists, but sufficient to drive a 0.1 percent contraction over the second quarter. Growth is believed to have rebounded in July, but most observers – including the Bank of England – expect the country to slide into recession as consumer spending crashes into the end of the year. The pound is struggling to break out of the 1.21 – 1.23 range against the dollar as shifts in risk sentiment drive price action.

US import prices likely fell in July, down roughly 1 percent as falling energy costs and a strong dollar reduced the country’s customs bill. This will come after Wednesday’s release revealing a flatlining in consumer prices between June and July, and yesterday’s data showed producer prices rising at the slowest pace in a year.

The University of Michigan’s consumer sentiment index should show an improvement, jumping from 51.5 percent in July to 52.5 in early August. The utility of the report, set for release at 10:00 am, is heavily constrained by political polarization, but both the overall consumer confidence measure and the inflation expectations sub-index are likely to have brightened in line with dropping gasoline prices.

Karl Schamotta, Chief Market Strategist

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