The dollar is slipping from a six-week high reached last night, ahead of US inflation data that is seen bolstering the case for lower interest rates. Equity futures are edging higher, Treasury yields are moving sideways, and currencies are back to trading in tight ranges as participants keep their powder dry.
The latest in a series of market-moving political upsets came last night when President Biden turned in a disastrous performance in a televised debate, inviting questions from Democratic officials as to whether he should remain in the race. Struggling to counter a confident and falsehood-spewing Donald Trump, Biden’s weak speaking cadence, confusion on important data points, and meandering responses triggered a collapse in betting odds, with prediction markets pointing to a 15-point decline in the likelihood of securing a second term. Yields rose and the dollar climbed against the Mexican peso, Canadian dollar and euro as market participants positioned for lower corporate taxes and more difficult relationships with major US trading partners.
Four months remain before voters go to the polls – an eternity in US politics – and many uncertainties remain. If last night’s event fails to make an impression on a deeply-polarised electorate, polls may shift less dramatically in the coming days, driving betting odds and market valuations back toward pre-debate levels. A misstep by either candidate could send the race careening in an unexpected direction. And the sheer extent of Biden’s underperformance on the debate stage could lead him to step aside, allowing Democrats to nominate a younger, more formidable challenger to Donald Trump. Either way, we’re sticking with our belief that volatility expectations in financial markets – currently well below historical norms – remain too low, raising the likelihood of a rude awakening in the coming months.
This morning’s release is expected to show the Fed’s preferred measure of inflation slowing to its weakest pace this year. With several major components already published, the core personal consumption expenditures index is seen rising between 0.1 and 0.2 percent in May, up just 2.6 percent on a year over year basis as lower gasoline costs and dropping goods prices translate into an ebbing in inflation pressures.
More broadly, the US economy is showing clear signs of slowing momentum. Data out yesterday showed core durable goods orders moving into contraction, and the number of people on unemployment benefits rose by more than expected, pointing to stronger headwinds ahead for real growth. The gap between economic surprise indices – which measure differences between economist forecasts and realised results – in the United States and other major economies has moved deeper into negative territory, helping further deflate the “US exceptionalism” trade that animated markets through much of the last two years.
We think Chair Powell will outline a more dovish outlook in July, with a clear easing signal likely to come at the central bank’s Jackson Hole conference in late August. Some have suggested that political considerations could prevent a move in September – a pre-election rate cut could be seen to favour President Biden, but the same logic applies to a post-November move, which might be interpreted as an effort to bolster the next president.
More moderate messaging from politicians has helped keep volatility in the euro somewhat suppressed, but traders are nonetheless on edge ahead of the first round of voting in the French legislative election this Sunday. Far-right leader Marine le Pen is leading in polls with an estimated 35 percent of the vote, well short of the 50 threshold needed to obtain a majority, meaning that an outcome won’t become clear for at least another week, with Franco-German yield spreads vulnerable to further widening as a range of political parties work to form alliances.
Yesterday’s Bank of Mexico rate decision was slightly more dovish than expected, but market-implied policy expectations were left effectively unchanged. The Banxico, as the central bank is known, left interest rates unchanged, but a single vote was cast in favour of a cut, and forward guidance in the statement helped set the stage for future easing. A sentence which previously said policymakers would “assess the inflationary environment in order to discuss reference rate adjustments,” was replaced with one saying “the Board foresees that the inflationary environment may allow for discussing reference rate adjustments”. In an interview with Bloomberg after the decision, Governor Victoria Rodriguez said “Going forward, what we’re seeing is that we’ll have space to reduce the degree of restriction. Reducing the rate does not mean that we will stop being restrictive … exchange rate volatility has been reduced and now it is returning to the levels observed before the recent episode of financial turbulence”.