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Risk appetite falls into heavy week

Currency traders are squaring their positions this morning ahead of a series of potentially market-moving data releases and policy decisions in the coming days. The dollar is inching lower, two-year yields are holding above the 5-percent threshold, and equity futures are setting up for a softer session.

The subdued open comes after a week in which Treasury yields snapped higher, stocks fell, and the greenback broke an extended winning streak. With August core consumer prices, producer prices, and retail sales all coming in hot, investors began to lose hope in a rapid pivot toward looser monetary policy from the Federal Reserve, while a series of looming threats – a US government shutdown, an auto strike, and rising oil prices – helped dampen risk appetite and hurt the US exceptionalism trade.

Republican House Speaker Kevin McCarthy proposed a dead-on-arrival funding bill last night, doing little to avert the risk of a US government shutdown. With McCarthy facing an ouster from fractious ultraconservatives on the party’s right wing, the plan would enforce an 8-percent spending cut on domestic agencies, refuse requests for more Ukraine aid, resume construction on the border wall, and deny asylum to migrants – provisions which are already facing opposition from Republicans, and would almost certainly fail in a Democrat-dominated Senate. The government is due to cease operations on October 1, with a recent estimate from Goldman Sachs suggesting that roughly 0.2-percent of gross domestic product will be lost in each week that the shutdown continues.

The United Auto Workers strike against the Detroit Three automakers is entering its fourth day, with both sides remaining far apart on key demands. Wider strike activity could push unemployment levels higher (although the effects might not be visible with non-farm payroll reports halted during a government shutdown) and a slowdown in production across Ford, General Motors, and Stellantis – which control a combined 40 percent of US auto sales – could exacerbate parts shortages and push vehicle prices higher, repeating some of the pandemic’s impact on overall inflation levels.

Brent crude prices are nearing the $95 mark as Russia and Saudi Arabia restrict supply and inventories retreat in the face of still-robust consumption levels. A three-week rally has seen the global benchmark and its North American equivalent – West Texas Intermediate – push toward 15-month highs, threatening to hit consumption among the lowest income tiers in the economy while raising inflation pressures – just as central banks move closer to ending monetary tightening cycles. Traders will be listening closely when Saudi Energy Minister Prince Abdulaziz bin Salman addresses the World Petroleum Congress in Calgary later today, but the supply response from North American producers could determine the sustainability of the rally in coming months. We suspect market momentum could carry prices over the $100 threshold in coming sessions, but slowing global demand and rising US output should ultimately cap the rally well below levels reached historically.

The Canadian dollar remains tightly anchored around the 1.35 mark against the greenback, hemmed in by signs of slowing domestic activity, but also sheltered against a broader erosion in risk appetite by the rise in oil prices. Tomorrow’s inflation report could see the exchange rate break higher, but we suspect most market participants will remain convinced that the Bank of Canada is done hiking rates.

The euro is almost imperceptibly higher after European Central Bank Governing Council member Peter Kazimir warned he wouldn’t “rule out the possibility” of further hikes, saying that it would be “necessary to stay here for quite some time and spend the winter, spring, and summer here”. Markets have long expected the Fed to begin its monetary loosening cycle prior to the ECB, with rates ultimately cut at a faster and more decisive pace in the United States relative to the euro area.

The Fed is expected to deliver a “hawkish hold” on Wednesday, leaving rates unchanged and keeping further tightening on the table. Fireworks – if there are any – could be found in the accompanying “dot plot” summary of economic projections, which could move upward and outward, with the median official penciling a last move this year, and only three cuts in 2024 – as opposed to the four previously anticipated. Going into the meeting, market-implied odds on a rate hike by year end are sitting around the 35-percent mark, and the first cut is priced for June 2024.

Market Retreat Continues as Yields Climb
Hawkish Kashkari Comments Pour Cold Water on Markets
Market Momentum Fades After US Long Weekend
No news is good news
Dollar Cruises Toward Weekly Gain on Fading Easing Expectations
Twists & turns

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