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Markets mark time into Jackson Hole

Foreign exchange market flows are ebbing this morning, reflecting typical late-August trading dynamics. The dollar is inching lower, delivering gains in most major-economy currencies, equity futures are pushing higher ahead of the open, and ten-year Treasury yields are holding near post-2007 highs.

Last week, markets sold off as long-term rate expectations were ratcheted higher. Yields spiked to multi-decade peaks after minutes from the last Federal Reserve meeting showed officials remaining intent on keeping policy tight for a prolonged period of time, and as updated retail sales numbers pointed to resilience in consumer demand.

More broadly, the global economy is sucking and blowing at the same time, driving a widening in expected growth differentials and contributing to a divergence in exchange rate outcomes. The US economy continues to defy widespread skepticism, with upside surprises coming at a steady clip and pushing yields higher – even as both the euro area and China deliver disappointments, generating safe haven demand for the dollar. This broadly aligns with our last currency outlook (see here), but is happening on an accelerated timetable, suggesting that a reversal could come sooner than previously anticipated.


Citigroup economic surprise indices, weighted historical standard deviations, basis points

There are no major economic data releases scheduled for today, and the weekly calendar looks relatively light. The US will report home sales and durable goods orders and Canada will deliver its latest retail sales numbers before traders tune into Friday’s speeches at the Jackson Hole Economic Symposium.

North America


We think Friday’s remarks from the Federal Reserve’s chair could be a bit of a snoozer. With another payrolls report and more consumer price data set for release between now and the central bank’s September meeting, there exists no solid rationale for countering – or doubling down on – the bias toward higher-for-longer rates articulated in the last dot plot and meeting minutes. Instead, Jerome Powell might follow in Janet Yellen’s footsteps – and echo John Williams’ thoughts – by delivering a short speech focused on largely-theoretical changes in post-pandemic “neutral rate” estimates.

But there are no atheists in Jackson Hole. With markets currently priced for one more rate hike by year end, a subtle shift in Powell’s language could touch off a sharp adjustment in the expected policy trajectory and drive renewed volatility in foreign exchange markets. He might express a more dovish viewpoint by suggesting that rate settings are already quite restrictive – and set to become more restrictive in real terms – setting the foundation for cuts in early 2024. Alternatively, an emphasis on recent data – which showed a slight acceleration in “supercore” inflation and a surprising rise in retail sales – could lift yields across the curve and put more pressure on the world’s more indebted economies.

Powell’s words will come against a sharply-tighter rates backdrop, with benchmark ten-year Treasury yields holding near 16-year highs. Pressure on the world’s more indebted sectors and economies is ratcheting ever higher, and the odds on something breaking in the global financial sector are growing by the day.

Canadian retail sales data, out on Wednesday, is expected to show headline receipts remaining relatively unchanged in June, as per Statistics Canada’s initial estimate. But the ex-auto number – less vulnerable to supply chain-induced shifts – could show consumer demand holding up remarkably well, with spending rising 0.3 percent over the prior month. An advance estimate for July might show more of the same, with households seemingly shrugging off the Bank of Canada’s rate increases and ignoring warnings of economic headwinds ahead. We doubt this will last beyond September, and currency traders generally agree: the Canadian dollar is struggling to push above the 1.35 mark against the greenback as markets brace for a period of relative economic underperformance.

Europe


The week ahead is largely bereft of hard economic data for the euro area and United Kingdom, with markets left to focus on Wednesday’s August flash purchasing manager surveys and Friday’s final revision of Germany’s already-weak second-quarter gross domestic product numbers. Services-sector activity is likely to shrink on both sides of the Channel, and output in the euro area’s largest economy could signal a recession.

Against this backdrop, European Central Bank President Lagarde’s speech at Jackson Hole could prove more market-moving than Powell’s. Investors are currently assigning coin-toss odds to a move at the central bank’s September meeting, and any recognition of growing downside risks could see a pause becoming more likely.

We note that non-commercial (speculative) accounts cut short positions and pushed the net long position on the euro to $21.7 billion in the week ended last Tuesday, ending a three-week sequence of drawdowns. A change in Lagarde’s language might see this shift rather dramatically.


Net Long (+) or Short (-) Futures Position Held by Large Speculators, Billions USD

Asia Pacific

Chinese banks lowered their one-year prime lending rate by 10 basis points last night, but held off changing its five-year equivalent, surprising markets that had expected an across-the-board easing in lending conditions after last week’s central bank cut. The rationale behind the decision is somewhat mysterious, but could reflect the fact that average mortgage rates are already below the levels set in 2009, when China last launched a whole-economy stimulus effort. Strains on bank funding might also be playing a role. But after more than two decades of breakneck credit expansion – proxied here using the growth in M2 money supply – China’s imbalances are deep-seated, and policymakers may be reluctant to double down on a growth model that has reached its logical limits – even that means the economy underperforms for a while.

Change in M2 money supply, %

A will-they-or-won’t-they dynamic more familiar to romantic comedy fans continues to play out in the Japanese yen, with traders paying more attention to pronouncements from the intervention-prone Ministry of Finance than to changes in underlying fundamentals. The exchange rate remains tightly hemmed in around the 145 threshold with widening yield differentials applying downward pressure – even as intervention risks limit downside. Tokyo consumer price data later this week is likely to show “core-core” inflation running strong, supporting expectations for further adjustments in the Bank of Japan’s yield curve control policies.

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US Inflation Stabilises and Spending Slows, Supporting Fed Easing