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Markets Settle Into Wait-and-See Mode

The dollar continues to grind higher as traders stick to safe positions ahead of today’s inflation print and Federal Reserve decision. Equity futures are essentially flat, commodity prices are inching lower, and most major currency pairs are treading water.

This morning’s consumer inflation report is expected to show price growth cooling, giving Fed officials a modicum of reassurance as they plot a more cautious easing cycle ahead. Economists polled by the major data providers expect headline inflation to have risen 0.1 percent in May, slower than the 0.3 percent pace in the month before, with the core measure holding at 0.3 percent for a second month.

But a lot of water will pass under the bridge before the first conceivable rate cut this year. Three payroll numbers, two consumer price index updates, and three personal consumption expenditures reports will land ahead of the Fed’s September meeting, giving markets plenty of retracement opportunities.

Although there has been plenty of sturm und drang in financial markets since the last Fed meeting, very little has fundamentally changed on the economic front, with incoming data pointing to an almost-imperceptible cooling in activity levels. In the statement itself, we expect the central bank’s messaging to remain essentially unchanged relative to May’s edition – namely, that rates will remain on hold until officials gain confidence in inflation’s sustainable return to the 2-percent target. In the absence of an unexpected collapse in the labour market, which has decidedly not occurred yet, the “dot plot” summary of economic projections could point to two – and perhaps even fewer – rate cuts before year end. This might trigger some positioning-related volatility – particularly if Chair Powell sounds more dovish than expected – but will in reality only narrow the gap between market pricing and the Fed’s documented views. Lasting implications for policy expectations or long-term yields should be minimal.


The Canadian dollar is languishing near a two-month low against the dollar as traders assign roughly 65-percent odds to a back-to-back cut at the Bank of Canada’s July meeting. With core inflation continuing to subside, measures of economic slack remaining wide, and policymakers making no attempt at pushing back against an easing in financial conditions, these probabilities seem reasonably accurate.

The Canadian dollar’s path is by no means assured however. Divergence between the Bank of Canada and the Federal Reserve has been priced into swap markets for months, and with consumer confidence hitting a two-year high – see Bloomberg’s enormously useful survey here – while real estate markets show distinct signs of thawing, easing at subsequent meetings could progress more slowly than anticipated.

In the long run, we suspect that aggressively moving policy onto an accommodative footing could exacerbate the imbalances that put Canada in such a vulnerable position in the first place – namely, the country’s overreliance on creating wealth through property price appreciation, and its failure to deploy capital into productive uses. Using a “hair of the dog that bit you” strategy – which comes from the Middle Ages belief that a rabid dog’s bite could be cured by applying the same dog’s hair to the infected area – doesn’t cure hangovers, it only postpones them.

The euro remains under pressure as French and German bond spreads widen in the aftermath of this weekend’s snap election call from Emmanuel Macron. French debt instruments are now paying similar yields to their Spanish and Portuguese counterparts, suggesting that markets are becoming concerned about the country’s debt burden against a worsening political backdrop. We think policy uncertainty will decline after the election is concluded – Macron’s gamble on consolidating power looks reasonably well-founded – but also remain concerned that France’s propensity for credit creation will ultimately lead to a downgrade in its status as one of the euro area’s “core” members.

Mexico’s peso is continuing its downward spiral after sitting president Andrés Manuel López Obrador (AMLO) yesterday doubled down on his constitutional reform message, suggesting that the judicial system could be overhauled before he leaves office at the end of September. The prospect of a Supreme Court that is vulnerable to political capture has spooked markets since last weekend’s election, ending the peso’s long reign as the destination of choice for yen-funded carry trades.

We worry that the relationship between Claudia Sheinbaum and AMLO bears some of the hallmarks of a “proxy leader” dynamic. A number of Latin American leaders in recent history have attempted to side-step term limits by anointing successors with the clear intention of retaining a stranglehold on power, including Brazil’s Lula da Silva with Dilma Rousseff, Colombia’s Álvaro Uribe with Iván Duque, Argentina’s Cristina Fernández de Kirchner with Alberto Fernández, and Bolivia’s Evo Morales with Luis Arce. This has rarely worked out as planned – in virtually every case, the surrogate has started off in a weakened position, but has ultimately turned on the patron, generating political instability. Sheinbaum appears conflicted, seeking to forge a centrist path on governance while also ensuring that her predecessor isn’t offended. In a press conference conducted after AMLO’s comments, she made a delicately-worded appeal for calm, saying “Investors don’t have any reason to worry… But at the same time, there’s an agenda for the people of Mexico and a project for the nation that has to continue”.

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