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Price Action Cools As Barbecues Heat Up

Price action is turning choppy in financial markets this morning as liquidity begins to evaporate ahead of tomorrow’s July 4 holiday. Equity futures are flat ahead of a shortened trading session, fixed-income markets are seeing modest safe-haven flows, and commodities are range-bound as thinly-manned trading desks take risk off the table before Friday’s non-farm payrolls report.

The dollar and Treasury yields retraced some of their post-presidential debate gains yesterday after Federal Reserve chair Jerome Powell said the US economy is showing “signs of resuming its disinflationary trend,” helping bolster the likelihood of a rate cut in September. Speaking at a European Central Bank policy forum in Sintra, Portugal, Powell warned that officials want to see more data to be confident that “the levels we are seeing are a true reading of underlying inflation,” but acknowledged making “quite a bit of progress” in reducing price pressures – in May, headline consumer prices saw the weakest month-over-month increase in four years. The job market is “cooling off appropriately” he said, but “we have two-sided risks now more than we did a year ago. That’s a big change”.

The correction was limited, however, as stronger-than-anticipated job opening numbers offset the impact on rate expectations. The May Job Openings and Labor Turnover report showed the number of vacant positions jumping back to 8.14 million from a revised 7.92 million in the prior month, separations remaining steady, and the quits rate holding at 2.2, suggesting that workers felt fairly confident in their alternative employment prospects. The ratio of job openings to unemployed workers fell below the pre-pandemic peak, but remained well above historical norms.

This afternoon’s Fed minutes could shed some light on the extent to which officials are shifting focus toward the second side of their dual mandate. The Summary of Economic Projections issued after the meeting in early June suggests that job markets were still playing second fiddle to inflation in determining policy settings: committee members left their growth and unemployment forecasts unchanged, but raised their price and interest rate expectations. We doubt this will last – the balance of risks would suggest that labour markets will worsen in coming months, raising the likelihood of an early-autumn rate cut, followed by another toward the end of the year. Like-minded market participants seem likely to seize on any evidence of a dovish bias – implied odds on a September move are holding above the 60-percent threshold this morning, and could go higher.

Before the minutes are released, this morning’s jobless claims and services-sector sentiment gauge out of the US are likely to set near-term direction for most major currency pairs. Japan’s yen is stuck in a narrow trading range as speculators play chicken with the intervention-prone Ministry of Finance, the Canadian dollar is marking time in the run-up to Friday’s job reports, and the British pound is holding steady ahead of tomorrow’s general election, with implied volatility plumbing recent lows.

Fear levels surrounding this weekend’s French legislative election are plunging as rival parties work to deny the far-right National Front a majority. Between Emmanuel Macron’s coalition and the left-wing New Popular Front, at least 215 candidates have withdrawn from three-way “triangulaire” races in an effort to ensure that vote splits don’t inadvertently bolster right-leaning candidates, and most indications suggest that this will be successful: the odds on Marine le Pen’s party winning an outright majority in the 577-seat National Assembly are diminishing by the hour. The gap between French and German ten-year bonds has narrowed to levels last hit in early June, and the premium paid to enter “butterfly” option strategies – which can be used to hedge extreme moves – has fallen sharply, suggesting that traders are less concerned about a dramatic move in the currency’s value relative to the dollar.

An old-fashioned selloff in equity markets could be the most significant macro risk on the horizon. Estimates of probabilities derived from options on the S&P 500 suggest that participants are assigning less than 6.5-percent odds to a 20-percent decline in the index over the next year, marking the lowest level recorded since June 2007. I probably sound like Chicken Little at this point, but this seems unsustainably low – particularly after the index added more than $16 trillion in value over the last two years – and important for currency markets, given the high correlations that have emerged between global exchange rates and US stock prices.

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