As the hours tick down to this week’s key event risk – Nvidia’s latest earnings release – currency traders are moving to the sidelines and bidding up the greenback. The dollar is climbing against its major rivals, Treasury yields are declining, and North American equity indices are holding firm.
The Mexican peso is the clear outperformer on the currency league tables this morning, bouncing back from yesterday’s losses as fears of a diplomatic crisis abate. The exchange rate dropped in yesterday’s session after a constitutional committee approved Andrés Manuel López Obrador’s plan to remove checks and balances in the country’s judicial system, prompting US Ambassador Ken Salazar to follow his Canadian counterpart in calling the reforms a “major risk” to democracy. Selling accelerated when López Obrador announced a “pause” in relationships with the US and Canadian embassies, but then reversed when he clarified his comments, saying that communication with both North American governments would continue even as he ghosts the ambassadors themselves. The peso’s up 0.75 percent on the day, but remains a little over six percent weaker than in early July, when Claudia Sheinbaum came close to clinching a “supermajority” in both houses of Congress, clearing the way for AMLO’s power grab. Implied volatility across one-, three-, and six-month horizons is now well above levels hit during the early-August unwind in the yen-funded carry trade, suggesting that traders expect political turbulence to continue against a worsening fundamental backdrop.
The British pound is trading on a slightly softer basis, but remains near a two-year high as investors bet rate differentials will move further in the UK’s favour. The contrast on display between Friday’s appearances at the Jackson Hole economic symposium – where Jerome Powell abandoned any pretence at gradualism and endorsed a September rate cut while Bank of England Governor warned it was “too early to declare victory over inflation” – has supported the currency this week, and looks likely to keep the exchange rate floating in the low 1.30’s for now. We have long considered the pound the most mis-priced currency among the majors, but to a large degree, undervaluation has been diminished in recent months, and it could face difficulty in appreciating further.
Yesterday’s US Conference Board consumer confidence index solidly topped expectations, rising to 103.3 in August from a revised 101.9 in July, well above consensus estimates for a print closer to the 100 mark. Views on employment conditions darkened, however, with the “labour market differential” – the share of respondents saying “jobs are hard to get” subtracted from the number saying “jobs are plentiful” – falling to 16.4 percent from 17.1 percent in the prior month, down dramatically from a high near 47 during the post-pandemic boom. This suggests that a sharp decline in the unemployment rate is unlikely when updated numbers are published next week.
Today’s agenda looks fairly uneventful, excepting Nvidia’s after-hours second-quarter earnings update. The beneficiary of a serious case of fear-of-missing-out spending from other major technology companies is expected to report a 70-percent increase in second quarter revenues, and markets will be on tenterhooks as it publishes forecasts for the latter half of the year.
Tomorrow will bring an update in Statistics Canada’s assessment of the Canadian economy, with second-quarter gross domestic product numbers likely to show momentum weakening in line with the advance estimates provided last month. In real and real per-capita terms, growth levels remain well below long-run trends, underlining the country’s extraordinarily-high levels of indebtedness and lacklustre productivity ahead of the pandemic’s impact. But with rate expectations continuing their descent and borrowing costs beginning to decline, we wouldn’t be shocked by an upside surprise in the July growth estimate, given a previously-reported jump in housing starts, hours worked, and nominal retail sales volumes for the month. In the eyes of foreign exchange traders, Canada is no longer the “Saudi Arabia of the North,” but it is the tower crane capital of the world, and – for better or for worse – developments in real estate markets are seen as the key driver for overall economic growth.
It has become something of an economic commentary trope to describe every non-farm payrolls report as “the most important since the last non-farm payrolls report,” but next week’s iteration really does have blockbuster potential. After spending a few months describing the Federal Reserve’s policy path as “data dependent,” and then repeatedly emphasising employment risks in last week’s Jackson Hole appearance, Jerome Powell has set the stage for an extreme market reaction to the August print. Bond yields, equity indices, and exchange rates are all vulnerable to big moves, and we suspect traders will systematically reduce exposures in the run-up to the event itself. The dollar could remain in demand as this process unfolds.
Stephen Jen – he of ‘dollar smile’ fame – is attracting a lot of attention for suggesting that the greenback could face an “avalanche” of selling from Chinese companies repatriating capital as the Fed cuts rates. Jen may be correct: to some extent, rate differentials do influence the pace at which Chinese firms convert dollars into renminbi – when Chinese yields are substantially higher than those available offshore, and the currency is appreciating, exporters are more inclined to accelerate repatriation.
But we suspect that the effect may be smaller than feared. A broader measure of capital flows – which includes changes in foreign currency deposits, trade balances, direct investment, and central bank purchases – suggests that overall outbound money flows tend to peak when Chinese consumer confidence is weak, as it is now. Until the onshore property market stabilises and households turn more optimistic, it seems likely that rate differentials will remain tilted against the yuan, and US assets will continue to trade at a premium, forestalling anything more than a sluff* in the dollar.
*Yes, a small, typically non-fatal avalanche is called a “sluff”. And yes, I had to look that one up.