With the US economy showing more signs of exhaustion, traders are tiptoeing back into bets on policy easing from the Federal Reserve before year end. Treasury yields – which have provided the fuel for the dollar’s recent outperformance – are climbing off a two-day low, equity futures are advancing as odds on two rate cuts in 2024 creep higher, and the greenback itself is little changed.
US job markets cooled further last month. According to yesterday’s Job Openings and Labour Turnover survey, the number of open roles in the US fell from a revised 8.355 million to 8.059 million in April, bringing the vacancy-to-unemployment ratio down to 1.24, matching the pre-pandemic peak. The pace of hiring and layoffs remained effectively unchanged, and overall labour demand continued to outpace the supply of available workers – but the gap narrowed for a third consecutive month.
This morning’s services survey from the Institute for Supply Management might help counteract the negative mood. If, as economists expect, the headline index rises above the 50 threshold, up from 49.4 in the prior month, the outlook for the broader economy – which remains predominantly services-driven – could brighten somewhat.
The Canadian dollar is trading almost unchanged, but with the Bank of Canada’s latest rate announcement set to drop in less than two hours, we’re bracing for some whiplash price action. If policymakers opt for a rate cut, we strongly believe they’ll work to deliver a more hawkish set of accompanying communications that explicitly emphasises upside growth and inflation risks. The Canadian dollar could tumble and quickly reverse as the likelihood of a rapid-fire easing cycle falls. Alternatively, a decision to stay on hold should be couched in language that clearly telegraphs a July move. In such an event, the loonie might snap higher, only to reverse once traders have examined the statement and the guidance provided during the post-decision press conference.
But any volatility should be put into context. Despite an extraordinarily-high volume of noise around divergent economic conditions and monetary policy trajectories, the loonie has spent most of the last two years trading within a remarkably-tight range – particularly when set against its long history of extreme moves. We suspect hedgers have been lulled to sleep by this – we certainly have – and worry that the next volatility bomb will catch markets largely unawares. And whatever the catalyst is, we highly doubt it will come from a shift in monetary policy.
This week’s unwind in the Mexican peso carry trade appears to be meeting its logical conclusion, with the currency gaining a little more than 1.5 percent against the dollar over the last day. Fears of a sharp tack to the left under Claudia Sheinbaum’s leadership seem to have abated, with finance minister Rogelio Ramirez de la O reportedly assuring investors of an ongoing commitment to fiscal discipline and institutional independence in a call yesterday. Concerns over constitutional reforms look likely to exert drag on the exchange rate for a while – perhaps even beyond Sheinbaum’s October inauguration – but the spectacularly-wide rate differentials on offer should generate ongoing investor interest, helping the currency quickly recoup this week’s losses. Apologies for sounding like a broken record, but we remain convinced that risks to the peso – and to the broader carry trade – still have an epicentre located in Washington DC.
The European Central Bank will almost certainly cut rates tomorrow, but the pace of subsequent moves is in question. With the economy showing signs of acceleration and year-over-year money growth coming off its bottom, bloc-wide inflation is proving sticky and wage growth in the services sector is pointing to more stubbornness ahead. We think officials will stay decidedly cautious in the accompanying statement and press conference, and expect President Lagarde and her colleagues to push back against market projections for a two-year easing campaign composed of quarterly rate cuts. The euro could gain support from traders in the months to come as cross-Atlantic policy differentials shrink, with a breach of the 1.10 threshold against the dollar looming as a very real possibility.
