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Market Momentum Fades After US Long Weekend

The dollar is holding steady, Treasury yields are essentially unchanged, and equity futures are edging higher as US market participants return from the Memorial Day long weekend.

Both the pound and euro are trading near the tops of their respective trading ranges as economic growth prospects brighten and expected yield trajectories edge higher. A series of data releases over the last month have provided evidence of a bottoming in both economies, with last week’s purchasing manager indices delivering the clearest view yet into the improvement in sentiment that could underpin growth in the manufacturing and services sectors.

The European Central Bank is widely expected to deliver a rate cut at next week’s meeting, but we suspect policymakers will pair the move with explicit forward guidance warning markets against expecting additional cuts to follow at subsequent meetings. The Bank of England is seen following in August, with a similar template coming into play. Speculators piled into long positions on both currencies and reduced bets on the dollar for a fourth week last week as incoming data pointed to a narrowing in cross-Atlantic growth differentials.

A holiday-shortened week will get off to a slow start with this morning’s Conference Board US consumer confidence survey looming as the only data release with obvious market-moving potential before the pace begins to pick up again on Thursday. Echoing the University of Michigan’s measure, households likely turned more pessimistic in May as labour markets softened, prices remained high, and last autumn’s improvement in economic newsflow began to lose momentum. The San Francisco Fed’s Daily News Sentiment Index – which measures the economic sentiments expressed in 24 major US newspapers – turned less positive in early April.

On Friday, the Federal Reserve’s favoured inflation measure – the core personal consumption expenditure deflator – is likely to cool to its slowest pace this year. Markets may welcome this, but we don’t think policymakers will undergo any Damascene conversions. Price pressures are still running too hot for comfort, and the path ahead remains deeply uncertain, with shelter costs refusing to soften with expectations, and easy financial conditions generating distortions in other categories.

Canada’s gross domestic product report – also out on Friday – is expected to show the economy expanding 2.2 percent in the first quarter, up from 1 percent in the last three months of 2023. With the population surging, output likely contracted for a seventh consecutive quarter on a per-capita basis, further widening Canada’s performance gap relative to the United States.

According to swap markets, a summer rate cut from the Bank of Canada remains a near-certainty, with odds on a move at next week’s meeting holding near the 65-percent level, and policy easing fully priced in by July. We largely concur with this view. But there are niggling doubts: last month’s 0.8-percent jump in hours worked seems consistent with an improvement in labour markets, retail sales are surging, export demand is growing, and Statistics Canada’s preliminary estimate for April gross domestic product could point to a rebound that carries through into the hotter months. A “hawkish cut” – a drop in rates accompanied by a more aggressive rhetorical stance – is becoming increasingly probable as policymakers seek to balance clear evidence of underperformance in the Canadian economy with the upside risks posed by a potential re-acceleration in underlying fundamentals.

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