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Market Briefing: Slowing US Economy Weighs on Dollar

The dollar is holding steady after yesterday’s data showing a slowing in momentum across the world’s biggest economy. Business activity fell further into contractionary territory in early August, according to S&P’s composite purchasing managers index, which showed a second month of weakness in manufacturing and the all-important services sector. Data from the Census Bureau showed new-home sales falling to an annualized 511,000 in July – the lowest in six years, and well below expectations for a 575,000 gain.

Federal Reserve Chair Jerome Powell is expected shrug this off in Jackson Hole on Friday, saying that the economy remains strong, with robust consumer demand and tight labour market conditions likely to keep inflation elevated – implying that the central bank will need to execute a significant and sustained tightening in financial conditions to bring price growth back to target.

But with every day that passes, the less likely it is that Mr. Powell will succeed in “outhawking” financial markets. Weeks of aggressive comments from other officials – most notably non-voting member Neel Kashkari – have prepared investors for a more prolonged tightening cycle, and odds on 2023 rate cuts have already fallen dramatically.

The dollar’s early-June peak could still come under threat, but we think the run-up to Powell’s speech could represent a near-term high-water mark for the currency, with a buy-the-rumour-sell-the-fact dynamic coming into play in the moments after the text is released. Bets on lower dollar-denominated fixed-income volatility could lead to cyclical currencies outperforming in the months ahead.

The euro is trading back below parity after staging a brief rebound yesterday. Benchmark European gas prices climbed again this morning as traders hedged against a potential drop in energy supplies that could send growth into a tailspin. Russia’s state-owned Gazprom warned on Friday it would shut the Nord Stream 1 pipeline for three days, sparking fears of a more permanent geopolitically-motivated drop in throughput.

Momentum measures are unremittingly bearish, but — for those who believe in such things — the 96-cent mark (the low reached in September 2002) could act as technical support for the beleaguered currency.

Major crude benchmarks are extending their gains as robust demand and falling inventories combine with Saudi production threats to push prices higher. West Texas Intermediate is going for nearly $95 a barrel and Brent is back above the $100 mark after an interview on Monday in which Saudi Arabia’s energy minister Prince Abdulaziz bin Salman seemed to suggest the country was considering cutting its output to bring markets into line.

The US Energy Information Administration is expected to confirm the biggest two-week drop in oil inventories in almost a year. Data out at 10:30 is likely to confirm earlier reports of a 5.63 million-barrel drop in crude stockpiles last week.

The Canadian dollar is dancing to the oil market’s tune, making analysis of domestic fundamentals somewhat redundant.

US durable goods orders are expected to increase roughly 0.9 percent in July relative to June, but could flatline when the highly-volatile transport category is excluded. Further softness might come in the months ahead as businesses cut investment levels.

The Bank of Korea is likely to lift its benchmark rate by 25 basis points this evening. The central bank, which sets policy in a country that acts as a bellwether for the global manufacturing cycle, is beginning to reduce the pace of interest rate increases, with economic risks offsetting its inflation-fighting mandate. We expect more of this to come in other jurisdictions.

Karl Schamotta, Chief Market Strategist

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Higher for (even) longer