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Market Briefing: Goldilocks Flees as Central Bank Bears Return Home

Markets are extending losses after a protracted August selloff. Hopes for a “soft landing” are fading as central bankers systematically lift terminal rate forecasts and rhetorically demolish odds on a 2023 policy pivot – pushing monetary policy expectations firmly into economically-restrictive territory.

Ten-year yields are back at early-June levels, and the two-year Treasury briefly hit 3.5 percent for the first time since 2007 yesterday. Equity futures are down, energy commodities are dropping, and the dollar is grinding higher against its major rivals.

The Japanese yen is knocking on levels not seen since 1998 as rising US yields diminish its attractiveness to investors – and encourage its use as a funding vehicle in carry trades. The latest selloff began at last week’s central bank conference in Jackson Hole, Wyoming, when Bank of Japan Governor Haruhiko Kuroda outed himself as the lone dove amid a kettle of central bank hawks, saying “We have no choice other than continued easing until wages and prices rise in a stable and sustainable manner”. The currency could fall sharply if traders push it beyond 140 against the dollar – but the likelihood of a jawboning effort from the finance ministry is growing.

The euro’s gains are fizzling out just above parity, with yesterday’s stronger-than-consensus inflation print failing to materially narrow interest differentials against the dollar. Financial markets are now essentially positioned for a 75 basis point hike at next week’s European Central Bank meeting, but few investors expect policymakers to keep pace with their brethren at the Federal Reserve if high energy prices drive the economy into recession later in the year.

Raw materials prices are down across the board as the world’s biggest consumer continues its fight against coronavirus. China locked down the city of Chengdu and its 21 million residents this morning, showing that authorities remain committed to pursuing the COVID-zero policies that have contributed to a sharp economic slowdown. Data released by the National Bureau of Statistics last night showed factory activity and home sales dropping further in July, suggesting that demand destruction could grow in the months ahead.

The Canadian dollar is holding at sharply weaker levels after yesterday’s below-consensus growth print forced a widening in interest differentials with the greenback. A big second-quarter increase in business inventories was worrisome, suggesting the economy could suffer “bullwhip” effects as retailers wind down stockpiles. Economists also think a huge post-lockdown rise in household services consumption will fade into the third quarter, and dropping home prices are likely to derail activity in the country’s all-important real estate sector. After executing a 75 basis point hike at next week’s Bank of Canada meeting, central bankers could move to a more cautious data-dependent footing.

Weekly US jobless claims are likely to climb slightly from last week’s 243,000, but should remain consistent with an incredibly-tight labour market.

The US factory sector might move closer to contraction, with the Institute for Supply Management’s manufacturing purchasing index seen dropping to 52.0 from 52.8 in July.

Economists are expecting tomorrow’s non-farm payrolls data to show employers added 318,000 jobs in August, but the “whisper number” is moving down after yesterday’s softer-than-anticipated ADP number. A weaker release could alleviate pressure on the Federal Reserve, while a strong print could lift odds on a 75 basis-point move at the September meeting to near-certain levels.

Karl Schamotta, Chief Market Strategist

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